ING Bank - "The Fed’s campaign to reinforce a message that tapering is not tightening has seen the USD hand back the gains that by early July had, on some measures, taken it to its highest level for three years. Yet we feel that its recent weakening needs to be placed in the context of a USD that is still well within the ranges established so far in 2013. Our base case remains very much for the USD to enjoy a strong recovery into year-end, even if the catalyst for its gains is in danger of slipping into 4Q.
Aside from the occasional distraction (ie, US debt ceiling negotiations after Congress returns from recess on 9 September and German elections on 22 September), debate surrounding the Fed’s taper will be the crucial topic in the near term. ING’s economists narrowly prefer an 18 December announcement over 18 September or 20 October. However, with USD money market rates currently at a cycle low, the USD will prove insulated from renewed losses on this front. Even if increased expectations of Fed normalisation that gripped global markets in May and June proved something of a false start, the stop-watch is now running on the FOMC’s next major policy shift.
While this will serve to increase the sensitivity of markets to US economic data, an ECB pledge in early June to keep interest rates unchanged or lower was designed to dampen any replica of the US situation in the EU17. Furthermore, the ECB’s stance should act to limit the response of EU17 assets to a gradually improving activity outlook for the region.
In this respect, despite a rise in the trade-weighted value of the euro to its highest levels this year, any comment from President Draghi on this topic was conspicuous by its absence in his press conference on 1 August. It was perhaps because the more visible EUR/USD rate was still some way below the 1.37 seen in February that triggered a rebuke from the ECB. However, make no mistake, with the EU17 recovery fragile and export dependent, the central bank will be prepared to do what is necessary to curtail any EUR uptrend. In the first instance this would be in the form of a verbal protest, yet the option of an interest rate cut remains available.
More broadly, a more advanced US business cycle leaves us comfortable that the USD will enjoy a cyclical rally against the EUR, JPY and GBP. Volatility around major turning points or new chapters in central bank policy is to be expected, with the confused GBP reaction to the BoE’s new unemployment rate target announced 7 August being one example. However, as the dust settles, we retain our strong conviction that the USD will emerge far healthier."