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FX

Upcoming Fed Tapering and Rate Hikes May Support USD

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USD: The more hawkish than expected September FOMC decision in which Chair Powell signals tapering of US$120bln/month asset purchases likely before year-end, along with the committee being more confident in hiking rates starting around end-2022/ early-2023, supports a moderately stronger USD over the medium to longer term. Gains are likely to be selective and against currencies whose central banks are likely to lag the Fed in tightening financial conditions, particularly  the ECB (EUR), BoJ (JPY) and SNB (CHF).

 

EUR: ECB’s less-dovish stance at its September meeting has kept EUR in a tight range against USD. Going forward, EUR is likely to decline against USD as the US economy outperforms the euro area that may be vulnerable to continued weakness to the Chinese slowdown. On monetary policy, despite the ECB’s less dovish stance recently as it likely tapers asset purchases further when its Pandemic Emergency Purchase Program expires in March 2022, the ECB is still unlikely to hike rates over the next 12-18 months. This may likely result in rate differentials in favor of USD as the Fed may begin rates lift-off earlier. 

 

GBP: Factors supporting GBP currently include (1) subdued UK COVID-19 hospitalizations; (2) UK assets attractive from both valuation and post-COVID economic normalization angles; and (3) receding political risks regarding EU-UK negotiations on the Northern Ireland protocol and no Scottish independence referendum near term. With the Bank of England at its September meeting lowering the bar towards commencing hiking rates as early as November 2021, GBP is likely to get an added boost from UK’s monetary policy outlook which is now well placed to front-run the Fed. 

 

AUD: COVID-19 lockdowns persist in several Australian states, and moderating commodity prices amid slowing economic activity in China is likely to ensure the RBA remains the most dovish among the Commodity bloc central banks. However, vaccination progress has accelerated, and the Australian government has given up their zero COVID-19 policy which could result in the economy reopening sooner (by year-end). This could allow RBA to start further tapering of asset purchases by mid-February. With most of the negatives are now likely priced in, probabilities are skewed towards AUD upside over 6-12 months.

 

RMB: The recent regulatory clampdown in China has affected sentiment. Any systemic risk in the Chinese property sector could be manageable for China’s financial system though it may impact China’s longer-term macro outlook. There is, however, already a policy response from the PBoC via RRR cuts. RMB may therefore benefit from index inclusions of Chinese assets into global benchmarks, but the prospect of RRR cuts from the PBoC while the Fed gradually tightens could see the pace of RMB appreciation dramatically slow.

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