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Richard Franulovich, Head of FX Strategy at Westpac, suggests that the fall in US yields and the pricing out of a full Fed hike for 2019 might have been expected to produce more USD weakness than has been the case, especially against the interest rate sensitive Asian currencies.

Key Quotes

“Asian currencies have at best merely stabilised in recent weeks. It appears that the fall in energy prices and the broader tightening in US financial conditions are the more decisive swing factor.”

“Understandably there is a strong inverse correlation between the ADXY and US financial conditions; as US financial conditions ease the Asian currency index tends to firm and vice versa. Even though US yields have declined there has been no relief on the financial conditions front – they continue tighten as credit widens and equities fall.”

“The ADXY is undervalued but in recent weeks the ADXY’s equilibrium value has fallen sharply, unwinding some of that cheapness. The ADXY’s equilibrium value has fallen even though US 2yr yields have fallen in recent weeks too; the main culprit being the sharp fall in oil prices.”

“US growth expectations are suddenly cooling. The tumult in equities, a sharp widening in credit spreads and a patch of weaker data have all taken their toll.”

“The recent sharp decline in energy prices bears watching too; it will visibly depress headline producer and consumer prices and potentially CAPEX plans too; CAPEX plans in the regional Dallas Fed index plunged in November, no doubt a function of lower energy prices.”

“CAPEX plans in other regional PMIs remain firm but as US energy investment has surged it has accounted for a disproportionate share of total business investment. Apart from a higher USD, the 2015-16 soft patch in US growth and business investment was directly attributable to the earlier plunge in oil prices.”