Overvalued ILS
(Peter Rosenstreich, head of market strategy)
Expectation for a 25bp Fed rate hike in March has surged to approximately 80% probability from 30% only two weeks ago. US short-end yields have risen 5-10bp, giving USD further support (US 2yr yields now at 1.28%). Global stock markets continue to rally with the Dow ripping through the 21k level. The catalyst remains shaky as traders are pointing to the conciliatory President Trump joint session of congress address as providing markets time to focus on solid US economic data and hawkish Fed rhetoric. Incoming data from the manufacturing sectors indicates steady improvement as ISM manufacturing index increased to 57.5 against 56.2 expectations. EM currencies have been surprisingly resilient to the USD rally given the importance of US rates as primary driver of EM FX. Given the rise in rates we are suspect that the Israeli Shekel (ILS) strength against the USD is overdone. The Bank of Israel has been in a defensive position fighting to weaken the ILS. The central bank has purchased $50 million in January totaling around $2.6bn in foreign currencies. While on Monday, the BoI held it benchmark interest rates at 0.1% focusing on the weak inflation outlook rather than on solid growth. The Israeli economy accelerated above expectations to 4% in 2016, yet data suggests a deceleration in 2017 (especially factoring the uncompetitive ILS). Current central bank projections indicate a 15bp hike in Q4 and another in 2018. A widening US-ILS yields spread suggests that USDILS should trade higher near-term.
AUD ready for debasement
(Arnaud Masset, market analyst)
The Australian dollar has been the best performing currency among the G10 complex since the beginning of the year. The Aussie rose more 6% against the greenback and recovered from around $0.72 to around $0.77 at the beginning of February. This sustainable appreciation of the Aussie is mostly the results of two factors: Firstly, the broad dollar depreciation was especially marked against high-yielding currencies such as the Aussie and the Kiwi but also against safe haven currencies such as the Japanese yen and the Swiss franc. Secondly, the sharp increase in iron prices - together with the broad-based recovery in commodity prices - has helped boost expectations for the country’s growth outlook. Indeed, the Aussie is highly dependent on exports (around 20% of GDP) and its dependence on China’s health is also very high as roughly 34% (12-month average) of its exports go to the “Middle Kingdom”.
Despite this encouraging note, dark clouds are gathering on the horizon as the two factors mentioned above are losing momentum. Indeed, China’s iron ore port inventory rose dramatically this year and reached almost 130 million tons as of February 24th. On the other hand, over the same period, steel production continued to inch lower, suggesting that there is a strong imbalance between demand and supply. Finally, on a trade-weighted basis the Aussie is back to levels last seen in summer 2015, which makes the RBA very unhappy with the situation. Indeed, the central bank has reiterated many times that the Aussie is overvalued and may be ready to take some action to adjust this situation. Taking into account the two factors exposed above, we believe that the Aussie rally has come to an end and that a correction is looming. We do not exclude the RBA to cut rates next week but in our opinion it appears very unlikely as US-AUD rates continue to converge. We anticipate AUD/USD to return quickly toward $0.75 and do not rule out further weakness for the pair should the dollar rally continue with $0.74 as the next target.
Bank of Canada keeps rates unchanged
(Yann Quelenn, market analyst)
Yesterday the USDCAD surged above 1.33 after the Bank of Canada held rates its unchanged at 0.5%.
We believe that the BoC is still in wait and see mode since Donald Trump’s ascension to the oval office. The Fed is now expected to increase rates by March and there is clear monetary policy divergence between the US and Canada for the time being.
Trump’s policies are likely to weigh on the Canadian economy and the key issue remains around the NAFTA (North American Free Trade Agreement), which is likely to be renegotiated. The global outlook has not changed much and what the new US president will deliver is of very high interest for Canadian policymakers.
In any case, one cannot blame Trump for subdued economic conditions in Canada, whose central bank revealed in a short statement that its forecasts are in line with recent data.
It is nonetheless clear that fundamentals are mixed. Canadian wage growth has hardly picked up. However, it is worth noting that inflation spiked in January to its highest level in two years but we believe that this is a temporary effect due to higher commodity and oil prices.