The FX Winner

The USD had a mixed overnight despite downgrades in Q1 GDP forecasts and a rally in US treasuries; CHF, JPY, and EUR were the biggest gainers in G10. US trade data was weak; and the monthly budget statement showed a widening deficit. While the trade balance narrowed in February, it does not support a positive contribution to Q1 growth.

Economists have revised their US GDP forecasts for Q1 downward.  The trade numbers follow an IMF growth warning and an IEA report of a slowdown in oil demand growth. The IMF call for action on the US deficit comes ahead of an Obama speech today, where he is to outline an alternative path towards fiscal sustainability. Momentum towards a cut in fiscal spending is building. All this adds to pressure on the Fed to maintain easy monetary policy; Bullard suggests a likely pause after the end of QE2, with tightening only to begin in the winter. We expect today’s March retail sales data to rise to 0.6% after surging 1% in February, but the rise will likely be a result of rising prices rather than real spending, further highlighting overall weakness in growth.

The softer outlook for US growth and increasing signs of a Fed on hold post-June reduce the incentives to switch to alternative funding currencies such as the CHF and JPY. Thus while risk appetite is likely to rebound, and though the rationale for a weaker JPY remains, that weakness may not be expressed against the equally anaemic USD.

But if US growth is entering a soft patch and rates are going to stay low, where are investors to put their excess cash to work? With few alternatives, they will continue to go to where the growth and tightening is: Asia, Latam & Australia. Inevitably this also leads EUR higher through recycling of intervention USDs.

In this context, two key events in Asia will shape risk appetite over the coming days. First up is tomorrow’s policy decision from Singapore’s MAS; on balance, markets are anticipating further tightening, which, if delivered, is likely to set off another shift to Asia and a rebound in risk appetite. A surprise on-hold decision from the MAS will have markets questioning whether this marks the beginning of the end of Asian tightening, potentially triggering another risk-off move as appreciation expectations are scaled back. The second event is Friday’s Chinese data, which will shed further light on the prospects for continued growth in the second-largest economy.

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