#Articles — 20.12.2022

Monthly Currencies Focus December

Guy Ertz, Chief Investment Advisor


1. The DXY index lost 2.7% over the month due to lower inflation expected in the USA on both the consumer spending (CPI) and producer (PPI). Expectations of FED rate hikes thus fell slightly over the month.

2. In the face of rising rates and falling consumer confidence due to inflation, real estate prices are beginning to fall, particularly in Sweden, and falls are expected in other G10 countries. Real estate monitoring will influence central bank monetary policy and exchange rates.

3. The EURUSD is now above parity thanks to a sharp fall in energy prices. We still target parity in the short term. The eurozone remains vulnerable to war and a possible new wave of Covid in China that would slow economic exchanges between the two zones. Over the next year, the expected fall in US bond yields should be favorable to the euro.

4. The New Zealand Central Bank raised rates by 75 bps and said rates should increase faster than previously expected. We are now more bullish on the NZD for the 3-month horizon.

5. The yen could benefit from a lower rate differential with the dollar. We adjust our target for the ZAR to reflect our concerns about current account balances.



Gradual recovery of the EUR

The euro appreciated against the dollar over the past few weeks. The EURUSD is now well above parity (value of one euro).

The euro benefited from weaker than expected inflation in the United States and the likely smaller rate hikes going forward. Indeed, the Fed downshifted to a 50bp pace of tightening at its December 14th meeting. This brought the policy rate to 4.5%. Despite the improvement in the inflation, the communication was still cautious suggesting a further 50bp hike in February. This should be the end of the cycle with a terminal rate at 5%. Moreover, natural gas prices are now far from their peak reached at the end of August and this improves the terms of trade for the eurozone relative to the US.

Leading suggest that the eurozone resists better than expected. Indeed, consumer confidence picked up in November even if it remains at a low level. The eurozone manufacturing PMI came out at 47.1 in November, up from October. The business surveys also highlight the reduced pressure from input prices and the easing of supply chains constraints.

Over the next 3 months, the euro zone could continue to be penalized by weaker growth, in particular due to the income squeeze suffered by households. Energy prices could rise again and hurt the euro zone's current account balance. Over the next 12 months, the gradual fall in US bond yields over 2023 relative to the eurozone should accelerate the depreciation of the dollar against the euro.

We adjust our 3 months target to 1.03 and maintain  our 12-month target at 1.08 (value of one euro).


Neutral view

The GBP was broadly unchanged over the month fluctuating in a 0.87-0.86 range.

The Bank of England (BoE) raised its policy interest rate by 50bps at its December meeting. This brings the key rate to 3.5%. The market expects a terminal rate of 4.5% in August 2023 for the UK against 2.8% for the eurozone.

We think the UK recession and the current account deficit will be headwinds for the GBP in the near term. The UK recorded negative growth of -0.2% in Q3 and could record a second negative quarter in Q4. For the year 2023, we expect -0.9% growth against     -0.5% in the eurozone. The Composite PMI is still in contraction (48.2) and private sector output fell for the fourth time in a row.

The current account deficit, which already reached £33.8 billion in the 2nd quarter, will most likely widen more in the coming quarters.

We maintain our 3-month target at 0.88 and one year at 0.86 (value of one euro).



Low inflation in Switzerland supports the CHF

The Swiss franc depreciated slightly over the month. However, the currency should benefit from rising central bank rates.

Indeed, the Swiss National bank (SNB) raised its rates by 50bps in December, in line with consensus. The monetary policy remains too expansionary according to the governors of the SNB with inflation risk on the upside.

The current account reached a record in Q2 at 8% of GDP and this trend could continue with the Q3 figures. Inflation in Switzerland is much lower at 3% against 10%. This is an argument for a Swiss franc which should remain strong.

The manufacturing PMI fell to 53.9 from 54.9 in November. This is explained by a decline in new orders and stocks purchased. However, this index level still  suggests expansion and shows the resilience of the Swiss economy.

The good fundamentals of the Swiss economy should continue in 2023 and we are thus neutral compared to the current level of the currency.

We maintain our target at 3 months at 0.96 (value of one euro) and one year at 0.98. 



The worst could be behind for JPY

The JPY has lost momentum last month despite the better outlook for inflation and rates in the United States that put the dollar under pressure.

The JPY has gained momentum last month in the light of central bank policy shift.

On December 20, the Bank of Japan (BoJ) surprised markets by adjusting the central bank’s yield curve control program. The 10-year yield will still be constrained but the limit is now 0.5% instead of 0.25%. Until that date, Governor Kuroda was seen as dovish and no changes until the end of his mandate were expected. This surprising decision led the yen to surge to a four-month peak against the dollar.

Inflation soars to 40-year high. Core CPI reached 3.6% driven by persistent yen weakness and imported cost pressures. However, Kuroda emphasized that this shift in the central bank policy is not an interest rate hike. The BoJ expects the inflation to decrease below 2% next year.

The composite PMI fell back into contraction at 48.9. This is explained by cooling demand and acute inflationary pressures.

As the imports exceeded exports and inflation rose, Japan recorded a current account deficit of $64,1 billion in October. The trade deficit could limit the appreciation potential of the Yen.

We change our 3-month target to 135 (value of one USD) and we adjust the 12-month target to 130. There is more upside.



Close to our targets

The SEK worsened slightly over a 30-day horizon.

The Swedish central bank raised its rates by 75bps and thus brought the key rate to 2.5%. It also signaled that further hikes would be forthcoming to combat inflation, which is now at 9.5%. Terminal rate expectations increased sharply after the meeting by 3.25% in the fall of 2023 against 2.5% previously.

Sweden recorded current account surplus in the first three quarters of 2022, but this should be reduced sharply in Q4 due to the increase in energy prices and the weakness of the eurozone on which the country depends heavily for exports.

The manufacturing PMI fell to 45.6 in October from 46.6 in October due to both weaker production and new orders.

We keep our 3- and 12-month targets to 11 (value of one euro). This suggests a stable SEK compared to current levels.



Upside for the NOK

The NOK depreciated moderately over a month. The currency remains sensitive to risk appetite and is often positively correlated to equity performance, which explains its depreciation since the beginning of the year. It is also the least liquid currency in the G10..

In December, the central bank raised its policy rate by 25bp to 2.75% to fight inflation. Economic activity remains stable, and the unemployment rate is at an all-time low. In addition to international factors, this creates high inflation at 6.5%. Inflation however came down from the peak.

The current account balance reached a record level in Q3 at 507.6bn. This surplus should continue for the last quarter thanks to an improvement in the terms of trade thanks to energy prices. This is a bullish factor for the NOK.

We keep our 3- and 12-month targets (value of one euro) at respectively 10.2 and 9.8. This suggests an appreciation potential from current levels. 



Rebound expected

The Australian dollar appreciated more than 2% during the last month due to an improved risk sentiment  that weighed on the US dollar. The AUD being a risk-sensitive currency has benefited from this improvement.

The Australian central bank raised its rates by 25bps during its meeting in early December, bringing the cash rate to 3.1%. Markets see the terminal rate at 3,7% by mid-year. The RBA could continue to adopt a more dovish tone, especially since the rise in rates leads to higher mortgage payments.

The country is a commodity producer and sustained high prices as well as the expected recovery in China are bullish factors for the AUD.

We keep our 3-month target at 0.66 (value of one AUD) and our 12-month target at 0.70. This suggests an appreciation potential from current levels.



Hawkish tone from the central bank

The NZD gained almost 6% against the US dollar in recent weeks thanks to the anticipation of a higher terminal interest rate from the Reserve Bank of New Zealand (RBNZ).

Unlike other central banks, the RBNZ shows no sign of approaching the terminal rate in the current cycle. The New Zealand economy is experiencing sustained inflation at 7.2% due to international factors and domestic demand driven by an unemployment rate of only 3.3%.

The central bank raised its rates by 75 bps, bringing the cash rate to 4.25%. It said it would have to raise rates faster than before to bring inflation under control although it will create a recession in 2023 and a potentially big drop in real estate prices. High rates in New Zealand and good economic fundamentals will be a support factor for the currency.

The manufacturing PMI fell for the first time below 50 in October due to a drop in new orders and a weaker outlook on production. This suggest a slowdown in activity.

We keep our 3-month and 12-month target at 0.62 (value of one NZD). This suggests a stabilization of the NZD after the recent strong appreciation. 



Upside for the CAD

The CAD lost 2.2% over a 30-day horizon due to retreating oil prices.

The Bank of Canada has raised its policy rate by 50bps at the beginning of November to bring the key rate to 4.25%. It surprised markets, which were betting on a 25bp increase. A rate hike of 25bps is expected at the meeting in the end of January. Canada’s annual In October, inflation rate was at 6.9% remaining unchanged from last month and in line with expectations. Higher interest rates are expected to cool the overheating economy and the market prices a terminal rate at 4.5%.

As an energy exporter the CAD saw its terms of trade improve in 2022. This helped the economy to have a trade surplus of over CAD 1 billion in October. However, the manufacturing PMI is not particularly well oriented, reaching 49.6.

Deposit rates are now slightly above 4.3% and are a favorable element for a stronger CAD.

We maintain our 3-month target at 1.35 and 12-months target at 1.30. This suggests an appreciation potential from current levels.



Gradual recovery

The CNY appreciated over a month despite recent fears of resurgence among Covid cases in China.

China’s government is easing its zero-Covid policy. However, rising caseload and growing infection fears are likely to uncertainty high in the short-term.

The Chinese central bank maintains an expansionary monetary policy. It will offer cheap rates to financial companies to buy bonds from real estate developers. These loans should be at a lower rate than the benchmark rate and are intended to address mistrust of the sector. Moreover, the low inflation encourages a dovish monetary policy. In fact, China’s CPI eased to 1.6% year-on-year, due to a slowdown in food costs. This lowest figure since March.

In 2023, the resumption of growth in China and the expected fall in US short interest rates at the end of next year will be supportive factors for the YUAN.

We have our 3- and 12-month targets at 7.1 (value of one dollar). This suggests a stabilization over the next year.



Turning neutral on INR

The INR depreciated by 1.5% this month. With an expected growth of 6.2% in 2023, India will be a strong contributor of global growth next year. The country could attract capital, and this will be a rather bullish factor and partly offset the current account deficit. We turn therefore neutral on the Indian currency.

India’s inflation dropped to 5.88% over a year, well below consensus and the lowest figure since December 2021. The result was due to strong base effect and slower increases in food prices.

The current account deficit is expected to reach nearly 4% of GDP in 2023. The PMI manufacturing is thus well oriented at 55.7 thanks to a good level of production and growing order books. Inflationary pressures are weaker.

The repo rate is currently at 6.25%. The Reserve Bank of India raised rates by 35bps in December and the terminal rate should then be close to 6.7%. The drop in inflation expected in 2023 will allow for positive real returns. Indian debt offers attractive carry with a rate around 7.30% for the 10 maturity.

We maintain our 3- and 12-month target at 82 (value of one dollar). 



Close to our targets

The ZAR appreciated by nearly 3% in November ahead of slowing monetary tightening from the FED.

The Reserve Bank of South Africa (SARB) raised its rate by 75bps to 7% in order to limit the inflation in a context of high food and fuel prices. The central bank also lowered its growth expectations for 2023 from 1.9% to 1.8%. However, power outages could cut growth by 0.6%.

South Africa recorded a current account deficit of ZAR 18,1 billion in Q3, above the prior quarter and consensus.

Business conditions strengthened in November as evidenced by the PMI Composite at 50.6. However, some firms continued to report weak economic condition.

We maintain our 3-month target to 18. We change our 12-month target from 16 to 17.5 due to growth and current account concerns. It suggests small appreciation potential from current levels.