Nomura – EUR versus the Antipodeans
EUR/AUD and EUR/NZD have been on a bit of a rollercoaster over recent weeks. The
more positive tone from President Draghi should refocus the market on the looming shift
by the ECB. This, and the flow backdrop, should underpin EUR. By contrast, we continue
to see fundamental AUD headwinds. We expect EUR/AUD to remain supported on dips
and to retest recent highs as the Eurozone economy strengthens. Given our more
cautious NZD stance, EUR/NZD also looks to have more upside potential.
EUR/AUD and EUR/NZD rebounding
After touching its highest level in close to a year in early June (1.5299), which was in-line
but slightly earlier than our end-Q2 projection, EUR/AUD fell back. Many were asking if this
retracement could continue, but the more constructive comments from ECB President Draghi,
particularly that deflationary forces are being replaced with reflationary ones, have buoyed
EUR/AUD (Figure 1). The shift in President Draghi’s tone should refocus the market on
the ECB’s looming policy normalisation path, which we expect to be announced at the
September meeting. This process remains a medium-term positive for EUR and EURcrosses,
such as EUR/AUD, particularly if the Eurozone continues to perform strongly,
as our economists forecast, and based on the AUD headwinds that remain (see
below). In a similar vein, against our more cautious near-term NZD stance, EUR/NZD
also looks to have more upside potential. In our base case, EUR/NZD rises back above
1.60 by end-Q3.
More than just the ECB, but….
Looking back, it was more than just disappointment in the ECB’s then cautious tone at its
June policy meeting that drove EUR/AUD to partially unwind of the appreciation
experienced in the wake of the French Presidential election. From the AUD-side, there
were some supportive factors, including: a) consolidation in Australia-centric commodity
prices; b) stability in Chinese growth momentum; c) buoyant market risk sentiment and
suppressed market volatility; and d) a relative shift up in RBA interest rate expectations
after the RBA brushed off the “soft” Q1 GDP report and May employment data exceeded
In line with its elevated correlation over recent months, the re-pricing of the risk backdrop and the shift in the Eurozone-Australia swap curve spreads (averaged across 2, 5 and 10yrs) guided EUR/AUD lower (Figure 2). However, we think there is a bias for relative interest rate differentials to revert back to where they were, favouring a higher EUR/AUD.
In contrast to the outlook for the Eurozone and EUR, we continue to see various fundamental headwinds facing both Australia’s economy and AUD. Specifically, rebounds in Australian commodity prices should be stifled by the unbalanced nature of these markets, largely due to the ongoing increases in supply coming on line while, on the demand side, the gradual moderation in Chinese growth from a peak in Q1 continues.
Likewise, we hold a relatively more downbeat assessment of Australia’s economy, with high levels of debt and negative real wage growth a headwinds to consumption. At the same time, leading indicators point to fading growth support from the housing investment cycle. Also, even though there has been an improvement in the labour market, the underutilization rate remains high, indicative of ongoing excess slack and persistently low wage growth. This will keep inflationary pressures muted. Despite the RBA’s upbeat outlook, we continue to argue that cash rate risks remain tilted to the downside over the next 12 months. We expect the RBA to substantially lag the more hawkish turns by some of the other major central banks. The mix of lower commodity prices and our bias for some more policy easing, rather than tightening by the RBA, should drive AUD to underperform on the crosses.
Looking beyond short-term volatility
Our bigger picture view remains conducive of a higher EUR/AUD and EUR/NZD. We anticipate a re-test of the early June highs in EUR/AUD. That said, the pace of appreciation is likely to be slower than the swift move up observed in late April/May. With ECB policy normalisation approaching, EUR’s sensitivity to incoming data should increase and, although we remain upbeat on the Eurozone’s prospects, the data are unlikely to be a one-way story. Nevertheless, we remain prepared to ride out the near-term volatility and expect EUR/AUD and EUR/NZD to be supported on dips.
As outlined, we expect the greater and more durable positive impulses, with respect to relative economic momentum and central bank policy regime shifts, to come from the EUR side. In addition to these factors, the flow picture should also underpin EUR’s appreciation path. On this front, we have found that foreign equity flows into the euro area have started to recover, and hedge ratios are lower. This has shifted the correlation between equity prices and EUR to neutral or positive, which should further enable EUR to benefit from the Eurozone’s positive economic fundamentals.
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