euro zone recovery stronger than most expect eur strength is here to stay!
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Euro zone recovery stronger than most expectEUR strength is here to stay!
Vasileios Gkionakis, Global Head of FX Strategy, UniCredit Group
May 2014
2
The themes that will dominate markets in the rest of 2014…
More risk normalization: our 2013 story of risk normalization played out very well; we expect it to continue for most part of 2014
Fed tapering: the Federal Reserve will continue with its gradual withdrawal of asset purchases; we expect this will conclude in 3Q14
Eurozone: the recovery in the Euro zone will be stronger than most expect on the back of domestic demand improvement
China: the gradual structural slowdown will continue
BoE: we expect the Bank of England to start a gradual hiking cycle in 4Q14, earlier than consensus
EM: as interest rates rise differentiation among EM will be a key theme this year
3
…and implications for the FX market in 2014
EUR: our out-of-consensus call for EUR-USD is at 1.45 by year-end. We expect the common currency to trade firm on the back of a stronger European recovery, an increasing C/A surplus, more demand for EUR-denominated reserves and inflows to Euro zone risk assets
USD: the US recovery and rising interest rates should support the US dollar against a number of currencies including JPY, CHF and SEK, on account of divergent monetary policies
JPY: the continuation of risk normalization alongside potentially further monetary policy easing by the BoJ should put downside pressure on the yen
CHF: as risk premia across the periphery of Europe compress further, the SFr should finally start to weaken as Swiss international portfolio investment returns to long term averages
CEEMEA: PLN should continue to outperform due to spill over from a strong German growth and domestic demand picking up; the HUF is likely to be the underperformer amidst measures that erode the carry further; TRY should benefit from high carry and improvements in the external account
4
2014 FX Themes: EUR to appreciate further; USD to strengthen against a number of currencies; Yen and SFr to weaken
Stronger growth in the US (we forecast 2.8% yoy for 2014)
Stronger growth in the Euro zone (we forecast 1.5% yoy for 2014)
Stronger growth in the UK (we forecast 3.2% yoy)
Yields in major developed countries will move higher (we forecast US 10Y at 3.5%; Bund 10Y at 2.2%; and Gilt 10Y at 3.6% by year-end)
These movements will impact currency pairs – although several other idiosyncratic factors will play a crucial role
5
EUR-USD: it is all about growth prospects!
1.20
1.25
1.30
1.35
1.40
1.45
1.50
42
44
46
48
50
52
54
56
58
Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13
EZ CompositePMI, 3M MA
EUR-USD (RS)
Correlation = 0.83
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%-10
-5
0
5
10
15
20
25
30
35
40
EA: Change inCredit Stds forBus Loans: Past3M: Overall(0+=tightened)QoQ Euro zoneGDP growth rate(RS)
Sources Haver, Bloomberg, UniCredit Research.
6
C/A surpluses should provide additional support to the common currency
Source: Markit, UniCredit Research
C/A as % of GDP is recording record high surplus…. …and it is not only about the core!
-7.00
-6.00
-5.00
-4.00
-3.00
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00M
ar-9
9
Mar
-00
Mar
-01
Mar
-02
Mar
-03
Mar
-04
Mar
-05
Mar
-06
Mar
-07
Mar
-08
Mar
-09
Mar
-10
Mar
-11
Mar
-12
Mar
-13
Euro zone UK US
Record high C/A as % of GDP
-20
-15
-10
-5
0
5
10
Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12
Spain ItalyPortugal GreeceIreland
7
…and consumer confidence is registering multi-year highs!... which should drive inflation higher in the near future
Sources: Bloomberg, UniCredit Research.
-1
0
1
2
3
4
5
-40.00
-35.00
-30.00
-25.00
-20.00
-15.00
-10.00
-5.00
0.00
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
EC Consumer Confidence
EZ CPI, yoy, %, lagged by 6M (RS)
8
Reserve managers have significantly increased their holdings in safe haven FX mostly at the expense of EUR…this is likely to correct as
perception of sovereign risk for Europe normalizes further
Source: IMF, UniCredit Research
25.5%
8.2%
164.2%
46.6% 43.9%
-0.5%
71.4%
14.4%
-20%
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
USD EUR JPY CHF
2Q10-2Q13 Growth in FXreserves
Average 12Q growth in FXreserves between 1999 -2010
17%
18%
19%
20%
21%
22%
23%
24%
25%
26%
Mar-99 Mar-02 Mar-05 Mar-08 Mar-11
EUR as % of allocated reserves, const x rateTrend until 2Q10
Evidence of a turn in the latest data
9
Eurozone equities have underperformed excessively their US counterparts…with sovereign risk now normalizing European equities are
likely to see significant flows which will support the EUR further
Source: Bloomberg, UniCredit Research
60
80
100
120
140
160
180Ja
n-04
Jan-
05
Jan-
06
Jan-
07
Jan-
08
Jan-
09
Jan-
10
Jan-
11
Jan-
12
Jan-
13
Jan-
14
EuroStoxx 50 (Jan 04 = 100)
S&P500 (Jan 04 = 100)
Massive underperform
ance
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
Jan-
05
Jan-
06
Jan-
07
Jan-
08
Jan-
09
Jan-
10
Jan-
11
Jan-
12
Jan-
13
Jan-
14
12M rollingcorrelation betweenSX5E and EUR-USD monthlyreturnsAverage for theperiod
10
There is little the ECB can do to prevent EUR appreciation in the medium term!
Verbal intervention is rarely successful in the medium term when not backed by a high probability of actual intervention…something the ECB has not done in the past!
The ECB could deliver another symbolic cut to the refi rate and/or announce a "Funding for Lending" scheme, in order to address the problem of fragmentation. These two measures could weaken the EUR in the short term but are unlikely to have a lasting impact
The only measure that could deliver a serious blow to the currency would be a full-blown QE (purchases of government bonds). However, this is highly unlikely in our view, because:
The central bank cannot engage in QE as a response to currency appreciation
Economic recovery is preceding better than most expected Inflation has shown signs of having bottomed in March should start
gradually picking up… ….in other words, the "bar" for initiating a QE programme is very high
in our view
11
The Euro zone recovery is having positive spill over effects to Central and Eastern Europe
30
35
40
45
50
55
60
65
Poland
Hungary
CzechRepublicTurkey
Russia
Manufacturing PMIs, 3M MAWith the exception of Russia, all trend-PMIs are firmly above the break-even level of 50…
…and more is to come!...given the historical correlations with the improving Euro zone PMI
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
CzechRepublic
Poland Russia Hungary Turkey
Correlations with EZ Manufacturing PMI
Source: Markit, UniCredit Research
12
Poland stands to benefit the most
PLN: the rebound in domestic activity and spill-overs from German growth should benefit Poland the most in the region and result in PLN outperformance. We forecast EUR-PLN at 4.05 by year-end
HUF: the worsening net international investment position, the large foreign ownership of domestic bonds which is subject to reversal on the back of Fed's tapering and the increased domestic liquidity that erodes the carry further should pose some headwinds for the HUF, which we think will underperform in CEE. We forecast EUR-HUF at 308 by year-end
TRY: we expect further improvement in Turley's C/A balance to around -4.8% of GDP this year; this, alongside the high carry should provide cushion to the Turkish Lira
RUB: we have pencilled in just 0.5% of annual growth in GDP. Russia will have problems managing the slowing of domestic demand, high inflation rates and the potential acceleration of capital outflows
13
Croatia: looking for growth drivers
We forecast a contraction of 1% in GDP yoy for this year; this is largely driven by declining private demand and cuts in government spending, although the recovery in the Euro area will have some partial offsetting effects
Downside risks exist to this scenario given the country's current credit rating
Fiscal consolidation has made steps in the right direction but more structural reforms are needed
Adoption of the EUR is still some years away; the current contraction in the economy makes meeting the convergence criteria more difficult; at the same time, Croatia needs to have the currency flexibility to become more competitive
The ratings outlook poses a challenge for the short-to-medium term. Only accelerated efforts toward addressing key structural economic and budgetary challenges can lead to an upgrade in rating
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