currency outlook-usd rally in 2015 – friend or foe rally in 2015.pdf · 8/01/2015 · usd rally...

Currency

OUTLOOKMurat ToprakFX Strategist, EMEAHSBC Bank plc+44 20 7991 [email protected]

Main contributors

Disclosures and Disclaimer This report must be read with the disclosures and analystcertifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Marjorie HernandezFX Strategist, Latin AmericaHSBC Securities (USA) Inc.+1 212 525 [email protected]

Joey ChewFX Strategist, AsiaThe Hongkong and Shanghai Banking Corporation Limited+852 2996 [email protected]

Clyde WardleEmerging Markets FX StrategistHSBC Securities (USA) Inc.+1 212 525 [email protected]

Dominic BunningFX Strategist, AsiaThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Robert LynchHead of G10 FX Strategy, AmericasHSBC Securities (USA) Inc.+1 212 525 [email protected]

Ju WangFX Strategist, AsiaThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

David BloomGlobal Head of FX ResearchHSBC Bank plc+44 20 7991 [email protected]

Daragh MaherFX Strategist, G10HSBC Bank plc+44 20 7991 [email protected]

Stacy WilliamsHead of FX Quantitative StrategyHSBC Bank plc+44 20 7991 [email protected]

Paul MackelHead of Asian FX ResearchThe Hongkong and Shanghai Banking Corporation Limited+852 2996 [email protected]

Mark McDonaldFX Quantitative StrategistHSBC Bank plc+44 20 7991 [email protected]

The USD bull run has further to go in 2015. This should be largely positive, particularly for those developed economies facing a deflation threat. Yet markets will also need to be mindful of the risks of excessive USD strength. We address these two contrary but inter-related aspects of our bullish USD view – the two faces of USD strength.

2015 currency outlooks We provide single-page summaries of our 2015 outlook for the most actively traded currencies in G10, Asia, CEEMEA and LatAm as well as precious metals.

USD rally in 2015 – friend or foe

MacroCurrency Strategy

January 2015

Play Video with David Bloom and Daragh MaherIssuer of report: HSBC Bank plc

http://www.research.hsbc.com/midas/Res/RDV?p=pdf&ao=20&key=53Pnl2bSjx&n=442714.HTM

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Macro Currency Strategy January 2015

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USD rally in 2015 – friend or foe (pg 3)

The USD bull run has further to go in 2015. This should be largely positive, particularly for those

developed economies facing a deflation threat. Yet markets will also need to be mindful of the risks of

excessive USD strength. We address these two contrary but inter-related aspects of our bullish USD view

– the two faces of USD strength. This is broken into two pieces: ‘Can a strong USD save the world?’ and

‘How extreme USD strength can destroy the world’.

What would it take to get a new currency accord? (pg 26)

International agreement on currency co-operation has been seen before. We explore the conditions that

led to the 1985 Plaza Accord to weaken the dollar to see what might be required to reach a new

agreement should the USD rise accelerate in 2015.

2015 Currency Outlooks (pg 32)

We provide single-page summaries of our 2015 outlook for the most actively traded currencies in G10,

Asia, CEEMEA and LatAm as well as precious metals.

G10 (pg 32) Asia (pg 40) CEEMEA (pg 44) LatAm (pg 48)

Precious metals (pg 50)

Summary

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Key events

Date Event

09 January BoE rate announcement 09 January ECB rate announcement 21 January BoJ rate announcement 22 January BoC rate announcement 25 January BoJ release minutes from December meeting29 January FOMC rate announcement 29 January RBNZ rate announcement 04 February RBA rate announcement 06 February BoE rate announcement 07 February ECB rate announcement

Source: HSBC

Central Bank policy rate forecasts

Last Q2 2015(f) Q4 2015(f)

USD 0-0.25 0-0.25 0.50-0.75 EUR 0.05 0.05 0.05 JPY 0-0.10 0-0.10 0-0.10 GBP 0.50 0.50 0.50

Source: HSBC forecasts for Fed funds, Refi rate, Overnight Call rate and Base rate

Consensus forecasts for key currencies vs USD

3 months 12 months

EUR 1.224 1.189 JPY 119.6 122.0 GBP 1.565 1.545 CAD 1.144 1.148 AUD 0.838 0.810 NZD 0.763 0.725

Source: Consensus Economics Foreign Exchange Forecasts December 2014

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The USD bull run has further to go. A year ago we

suggested that USD strength would be the dominant

theme in currency markets during 2014, a view

vindicated as the USD was the world’s best

performing currency. We expect a repeat

performance in 2015. For the rest of the world, this

should be a largely positive development,

particularly for those developed economies facing a

deflation threat. Yet markets will also need to be

mindful of the risks that any excessive USD strength

would create. In this report, we address these two

contrary but inter-related aspects of our bullish USD

view – the yin and yang of a strong USD.

Benevolent USD strength

In the first section of our report, we examine our

central case of helpful strength in the USD. A

weaker exchange rate has become a popular tool

in many developed markets to head off the

deflation threat. Some, such as Switzerland, have

directly targeted the exchange rate. Others,

notably Japan and the Eurozone, have sought

currency weakness indirectly through a loosening

of monetary policy, both actual and potential.

The success of this strategy relies upon the ability

of USD strength to act as the mirror to currency

weakness elsewhere. This is particularly the case

now given few currencies want to strengthen

against a declining EUR or JPY. The USD has to

remain the main safety valve.

In the past, this tolerance would be determined by

the impact of the rising USD on the US current

account deficit. But in today’s world where the

currency war is being fought to steal inflation

rather than exports, the constraint is whether the

US economy is strong enough to generate enough

inflation to withstand importing disinflation from

the likes of Japan and the Eurozone.

Strong US growth data during the second half of

2014 gives cause for confidence on this front, and

we continue to expect the US Fed to hike interest

rates later in 2015. Indeed, with the BoJ and the

ECB both likely to expand their balance sheet

further, the divergence in monetary policy will be

the key driver to USD gains this year.

Some will argue that much is already in the price

of the USD. However, the 10% rally in the USD

broad index since mid-2014 is rather modest when

compared to history. The ‘mega’ rallies of the

early 1980s and late 1990s saw the USD rise 90%

and 50%, respectively. Even stripping these out,

the average USD rally has been 20%.

Our forecast of additional USD gains may not be

enough to push inflation back to target in those

countries struggling with the deflation threat, but it

could buy them time and help prevent inflation

expectations becoming permanently detached from

target. Our forecast pace of USD strength suggests

it will be a helpful development for others.

The destructive dollar

The danger of this benevolent view of USD

appreciation is that it relies upon an assumption

that currency moves do not get out of hand. There

Executive Summary

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are a number of routes to a swifter and potentially

more destructive rise in the USD. In the second

section of our report, we examine three – namely

that Japanese policymakers lose control of the

JPY, that the EUR slides on re-ignited break-up

fears, or that the resultant USD surge provokes an

EM FX crisis.

Rhetoric from Japan’s policymakers suggests a

comfort not only with the direction of the JPY,

but also the pace and volatility of the move. This

could change. Successive QE and expectations of

more to come could see the JPY retreat turn into a

rout. Any sign of fiscal largesse and associated

monetisation of the deficit could see a similar

debasing of the JPY. Alternatively, rising inflation

expectations on successful Abenomics could also

see a much weaker JPY.

A sliding JPY could change the nature of the

currency war in a destabilising way. Japanese

exporters might seek to expand market share

rather than simply expand margins, a move from

translational to transactional gains. This could

draw other currencies in the region into the

currency war.

The key would be whether JPY weakness was

sufficient to prompt a shift in China’s FX policy

towards a competitive devaluation. We believe the

bar would be extremely high to any such a retreat

from China’s current FX policy reform and

internationalisation. Nonetheless, the threat that

China could become embroiled in the currency

war, however low a probability, could be the real

significance of a rapid weakening of the JPY.

In Europe, break-up fears are already on the rise

again in Greece. But the issue is more wide-

spread given rising support for euro-sceptic

parties across the EU. Primary surpluses in much

of the periphery this year also reduce the potential

cost of exit. Our aim is not to suggest the EU or

the Eurozone is about to break up. It is simply a

reminder that the market cannot rule this risk out

entirely. Furthermore, with the ECB’s bond

buying programme in the wings to provide

support, it is the currency which will most swiftly

reflect any rising break-up risk premium.

A more rapid appreciation of the USD would be

the likely mirror to any excessive weakening of

the JPY or EUR. In turn, this could cause

problems for EM FX which has already shown its

vulnerability to a stronger USD in 2014. The

global situation is overwhelming local factors, and

if we see far more aggressive USD moves in

2015, the likelihood of de-stabilising knock on

effects for EM FX would grow.

From Plaza Accord to a new accord?

One way of avoiding the negative implications of

excessive USD strength would be for governments

to co-operate on currencies. However, as we argue

in the third section of our report, a new agreement is

very unlikely without first seeing a new crisis. In

addition, any accord would have to go beyond a

mere agreement to stem the USD’s rise. It would

also likely be more complicated to draft than the

1985 Plaza Accord given the wider group of

countries that would be involved, and the divergent

policies currently in play.

Conclusion

The final section of the report provides single-page

summaries of our 2015 outlook for the most actively

traded currencies, together with tables of spot

forecasts. For now, we continue to believe the pace

and extent of future USD gains will act as a positive

force on the global economy, but our forecasts also

incorporate some tail risk that the outcome may not

be so benevolent. The yin and yang of USD strength

will remain a key 2015 theme.

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The USD bull run still has further to run in our

opinion. We believe this will ensure that it reign

supreme in 2015. Even though we have long been

advocates of a strong USD, we have revised many

of our forecasts further to reflect this expected

USD supremacy.

After all, the USD rally so far has been roughly

10% yet history shows a 20% rise would not be

implausible. USD weakness during the Fed’s QE1

and QE2 programmes was15-20%. US

policymakers may find it hard to push back against

similar tactics from other central banks. In any

event, it takes a 20% rally in the USD to trim US

inflation by 1.0%, so we are unlikely to be at the

point of policy push back from the US quite yet.

A stronger USD would help deliver a dose of

much needed inflation to those nations facing

excessively low inflation. While the scale of a

USD rally required to bring inflation all the way

back to target in the likes of the Eurozone would

likely be unpalatable to US policymakers, USD

strength will still help stave off the deflation

threat. The USD on its own may not be able to

save the world but it will certainly buy time.

In this report, we argue the nature of the current

USD rally is unlike any we have seen before.

True, expectations of US monetary tightening in

response to an accelerating US economy have

played their conventional part. But unusually,

much of this USD strength is the mirror of efforts

elsewhere to weaken currencies, not in a bid to

stimulate growth through exports, but to stave off

Can a strong USD save the world?

1. The USD's dominance is set to persist through 2015

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0.0

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BRL

PEN

NZD JP

YR

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KRW

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EUR

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MXN SE

KC

NY

INR

PLN

NO

K

Forecast spot return in 2015 %%

Source: Bloomberg, HSBC

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deflation and prevent inflation expectations from

becoming unanchored. Reviving exports is a

secondary objective at best. This is a currency war

where stealing inflation rather than growth is the

goal. Therefore, unlike previous USD rallies, this

one will not be tripped up by US current account

deficit concerns. The new feature is whether the

US economy can generate sufficient inflation

internally to tolerate the deflationary impact of a

stronger USD.

1) This time it is different

In the lexicon of investment, the suggestion that

“this time it’s different” is perhaps the most

terrifying. One fear is that in fact nothing has

changed, and that we are simply being led down

the garden path in assuming we now face a new

paradigm. Alternatively, we fear that we are too

attached to our previous view of the world and

will fail to spot a seismic change, always

anticipating a return to the old world order. In the

end, we react too late.

We believe the greatest danger for markets and

forecasters now is that they fail to adjust their

behaviour fully to reflect what is a very different

world for currencies. At the start of 2014, we laid

out our vision for the year in ‘Currency Outlook:

USD rally to spread its wings’, January 2014. The

message was clear and in 2014 the USD indeed

rose against the world’s actively traded currencies.

In divining the likely scale and scope of the current

USD rally, it is first important to understand what is

driving it and whether history can therefore act as a

guide. If we look at the two major periods of USD

appreciation in the past (1980-1985, 1995-2001),

there are some common factors:-

US economic growth is relatively strong

compared to other countries

US monetary policy is relatively tight too

An overseas crisis adds to the USD bid

The rally falters when the US current account

deficit is viewed as unsustainable

The US drivers to the USD rally

The relative stance of monetary policy is also

clearly the key element in the current USD rise.

This feels most obvious in the earlier example of

the rise in USD-JPY and the more recent weakness

in EUR-USD perhaps, but GBP-USD is most

illustrative. Chart 3 shows the tight relationship

between GBP-USD and expectations for 3m

interest rate differential between the UK and US by

the end of 2015. There has been a clear narrowing

of the expected gap as UK data has generally

2. Upside surprises on US growth are helping to feed the USD rally

3. Shifting relative rate expectations have also played their part in the USD rally

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DXY (LHS) US Activity Surprise Index (RHS)

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Jan-13 Jun-13 Nov-13 Apr-14 Sep-14

GBP-USDExpected Dec'15 3M rate differentials (UK-US), RHS

Source: Bloomberg, HSBC Source: Bloomberg, HSBC

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=f6psSnXI7E&n=399887.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=f6psSnXI7E&n=399887.PDF

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disappointed in contrast to the US. This, in turn,

has driven the USD stronger. It also means the only

other sizeable safety valve in global FX to release

pressure on the USD is now closed, leaving the

USD to do all the work on its own.

Crisis, what crisis?

Yet the drivers to this USD rally extend beyond

the racier outlook for US economic and monetary

policy. Past USD appreciations have been

augmented by crises outside of the US. The

Mexican crisis of 1982 curtailed the supply of

USD internationally, helping to strengthen the

USD. The 1997 Asian crisis saw the USD rise

sharply against many struggling emerging market

currencies. In the current USD rally, currency

weakness elsewhere is playing its role in driving

the USD higher, but the factors behind it are very

different and carry important implications as to

the likely longevity of the appreciation.

The potential crisis being faced by a number of

developed market economies is the deflation

threat. Charts 4-6 shows the current inflation and

the forecast for 2015 relative to the central bank’s

target (or assumed target where no official one is

available). The pattern is clear. For G10

currencies (chart 4), most central banks are facing

excessively low inflation. Our forecasts for 2016

suggest only 3 countries of the 34 we examine

globally are likely to see inflation above target.

Currency war moves to a new front

In many instances, the ability to reflate via interest

rates is totally exhausted with rates at or close to

zero. This has elevated the role of the exchange

rate as a tool in influencing inflation. For some,

earlier currency strength has been cast as the

villain in the story, the chief explanation for why

inflation has been lower than desired. With this

characterisation, preventing further currency

strength has become a popular strategy, most

overtly in Switzerland and the Czech Republic.

Others have used monetary policy to weaken their

currency, via whatever modest leeway still

remained on interest rates or by resorting to

unconventional easing. Japan and, more recently,

the ECB have been particularly notable adopters

of this strategy. They are replicating tactics used

by the US earlier in the cycle.

We created a framework to study the evolution of

the post-crisis currency war some time ago (see

‘Currency War, USD to soar: Turning bullish on

the USD’, May 2013), and we update the analysis

here. We grade 34 countries on how actively they

are seeking an economic advantage through their

exchange rate – or currency war appetite.

4. Projected inflation relative to target (G10)

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USD GBP JPY SEK EUR CHF AUD NZD NOK CAD

2016 HSBC Inflation Forecast Central Bank Inflation Target% %


https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=gXPb0RFXwa&n=372634.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=gXPb0RFXwa&n=372634.PDF

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Since that first report, the currency war appetite

‘score’ has risen considerably, reflecting the

increasingly interventionist global mood in FX

(Chart 7 shows how scores have changed for

individual countries). Interestingly, since May

2013, the overall score has been stable but this

hides some changes in terms of the countries at

the forefront of the battle. The US exit from QE

means its currency war appetite has declined, and

Japan has not been as aggressive in its efforts to

drive the JPY lower as in the past. By contrast, the

EUR score has jumped higher given the ECB’s

apparent determination to weaken the EUR via

ever looser monetary policy.

The scale of the deflationary pressures in the

Eurozone should not be underestimated. The

structural reforms being pushed through the

Eurozone emulate those of the Hartz reforms that

were enacted in Germany in the early 2000s (see

‘The deflationary consequences of Europe’s

swelling workforce… and comparisons with the

US’, September 2014). If successful this could

lead to massive growth of the Eurozone workforce

(indeed, twice the rate of growth of the US).

Without sufficient jobs we may be looking at a

decade of little or no wage inflation which will

continue to drag on overall inflation.

The deflation threat in the Eurozone and

elsewhere has created a new front for the currency

war. The motivation for those seeking currency

weakness is very different. Historically, currency

wars were a battle over market share in export

markets, designed to help support a country’s

balance of payments position and boost or

rebalance growth. In Australia and New Zealand,

this is still largely the case. The rhetoric and

intervention being used to push the AUD and

NZD lower reflects concern about what an

excessively strong currency might mean for the

trade balance. Australia wants a weaker AUD to

help with the economic rebalancing away from a

reliance on mining. New Zealand does not want

an excessively strong NZD to trip up the

economic recovery. This is the classical way we

thought about FX moves. However, we now need

to look at FX moves in a new light.

5. Projected inflation relative to target (Asia ex-Japan) 6. Projected inflation relative to target (LatAm and EMEA)

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2016 HSBC Inflation ForecastCentral Bank Inflation Target% %

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2016 HSBC Inflation Forecast

Central Bank Inflation Target% %


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From the ‘Old’ to the ‘New’

For many, currency weakness is now being used as a

tool to import inflation (or equivalently export

deflation) in order to bring inflation back closer to

target and head off the deflation threat. Central banks

do not want to allow inflation expectations to

become unanchored or, in the case of Japan where

deflation has been a long-running headache,

monetary policy is being used to try and re-engineer

inflation expectations higher. The exchange rate is

the tool of choice for fighting deflation.

So far, their efforts have been successful in

weakening their currency, reflecting the grip that

policymakers now have on financial markets.

There was a time when central bankers would

point to the power of the markets. But the global

financial crisis has shifted the balance, with a

sequence of massive policy initiatives and rescue

packages driving the centre of influence from

markets to policymakers. Now markets submit to

the power of central banks. The BoJ wanted a

weaker JPY and took steps to secure this outcome,

and the market gave it to them. The ECB has also

made it clear that a weaker EUR is a desirable

side-effect of their increasingly accommodative

monetary stance. In this iteration of the currency

war, the FX market has not put up a fight.

The limits of the currency war

But the challenge for policymakers is less with the

market than with each other. For example, the

ECB may want a weaker EUR to head off the

deflation threat, but other central banks in Europe

have similar hopes. The Riksbank will not want

the SEK to appreciate against a weakening EUR

or inflation in Sweden would move further away

from target, and a EUR-SEK floor to prevent this

happening remains a possibility. Switzerland and

Czech Republic already have floors in place to

reduce this risk.

USD the pressure valve

This is the crux of the problem. If no one is

willing to accept a stronger currency, then your

exchange rate goes nowhere. So far, the USD has

been the safety valve of currency strength that is

allowing these other currencies to weaken.

7. Central banks have become more activist in FX: January 2012 vs current

0

1

2

3

4

5

6

7

8

9

10

JPY

CHF

NZD

USD

AUD

GBP

EUR

SEK

NOK

CAD

ARS

COP

BRL

PEN

CLP

MXN

TRY

ILS

RON

CZK

RUB

HUF

PLN

ZAR

TWD

KRW

PHP

THB

CNY

MYR

SGD

IDR

INR

Jan-12

Mor

e A

ctiv

ist G10 Latam EMEA Asia

Less

Act

ivis

t

Source: HSBC

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If a given currency is stable against other

currencies apart from the USD, then the drop

against the USD has to be particularly pronounced

for the overall impact on the trade-weighted

exchange rate to be significant. Take the example

of the EUR. The ECB clearly wants a weaker

currency to help stimulate inflation. But many

other nations either do not want their currencies to

strengthen against a weakening EUR, so they take

steps to depreciate their currencies also (e.g.

Sweden’s unexpectedly large 50bp interest rate

cut in July 2013), or they do not want their

currencies to weaken against the USD.

Those currencies in shades of blue would be

relatively intolerant of strength, and they add up

to 40% of the total. We assume that GBP will

move by roughly half the amount that the USD

does against the EUR. This means that if the

Eurozone wants a 15% depreciation of its

trade-weighted exchange rate (the same as the

USD did during QE1 and QE2), it effectively

must fall roughly 33% against the USD.

8. ECB has manufactured a lower EUR

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Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15

EUR-USD

April 12 -Draghi: strengthof the EUR 'requires further monetary stimulus'

May 8 – ECB:the gov erningcouncil is‘comfortablew ith acting'in June

Sept 4: Policy rates cutby 10bp, taking depositrates further into the negativ e territory .

August 22 Draghi speaks at Jackson Holeand signalled a greater appetitefor additional easing

July 3 - policies werekept unchanged andDraghi once againspoke about thestrength of the EURbeing a ‘problem’


9. A weaker trade-weighted EUR requires a much weaker EUR-USD as many currencies will not budge against EUR

United States

China

Russia

Turkey

IndiaUAESw itzerlandSouth Korea

JapanBrazil

Poland

Czech Republic

Sw eden

HungaryDenmark

Romania

Croatia

United KingdomAv erage share of exports and imports of selected countries


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Given this observation, we would not be surprised

to see forecasts of below-parity in the market.

However, we believe there will be a US reaction

well before this point. If the focus of policy is on

getting inflation higher, the exchange rate that

may matter most is the one measured against the

USD given this should have the biggest impact on

imported food and energy costs. Trade-weighted

exchange rates mattered more when currency

wars addressed the balance of payments. With

inflation in focus, it is now the USD that matters.

2) How far can the USD rally go?

So the USD is central to the likely success of anti-

deflation strategies elsewhere, but it is also

therefore the most likely threat to success. Where

might it end?

US trade deficit is no longer the USD referee

In the past, USD rallies were hindered by the

damage the currency would do to the balance of

payments. An excessively strong USD would

cause the current account deficit to widen to

uncomfortable levels, raising questions about the

ability of the US to finance the shortfall. In a

world fixated by trade flows, currency strength

was self-correcting. Chart 10 shows the US

current account balance. When the deficit got

stretched, the USD rally would come to an end.

Today, it is less likely that the US current account

will act as the self-correcting mechanism for the

USD. It is simply not a fixation for the market in

the current environment. The US deficit has

narrowed from 6% of GDP in 2006 to just over

2% currently, creating quite a bit of breathing

space before it could move back to a worrying

level. The lower reliance on energy imports

following the discovery of shale oil and gas in the

US has also made the external imbalance less of a

headache. It is possible the deficit could come

back to haunt a strong USD many years down the

road. But like the currency war driving it, the

more likely headwind to the USD rally will come

from inflation, not the balance of payments.

How big is a big USD move?

First of all, we should consider what would

represent a “big” USD move. Even if we ignore

the “mega-rallies” of 1980-1985 (+90%) and

1995-2001 (+50%), the average USD rally has

been 20% and has lasted roughly a year. Chart 11

shows these USD rallies shaded in grey with the

size of the USD move.

10. USD current account deterioration has stopped previous USD rallies

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1961 1963 1966 1968 1971 1973 1976 1978 1981 1983 1986 1988 1991 1993 1996 1998 2001 2003 2006 2008 2011

US Current Account% GDP % GDP

Dollar rallies


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It would be hard for US policymakers to point to a

20% USD appreciation as a historical aberration.

In addition, currencies could fall quite far against

the USD before the US could justifiably

complain. After all, when the US conducted QE1,

the USD fell 15%. The USD also weakened in

anticipation of QE2 and during it too, falling 20%

in total. It would be disingenuous for the US to

carp about tactics of other central banks that it

employed only a few years earlier.

How much deflation can you take?

To be fair, so far there has not been much push-back

from US policymakers against USD strength. New

York Fed president William Dudley did observe

recently that “if the dollar were to strengthen a lot”

then it could affect growth and the “appropriateness

of a given monetary policy”. But we are still in the

realms of “if”, and so the question is what might

represent “a lot”? At what point might USD

strength begin to lower the US inflation outlook

sufficiently to delay Fed interest rates hikes, thereby

weakening the USD?

Much academic energy has been spent gauging

the pass-through effect of a currency move on

GDP growth and inflation. HSBC’s estimates on

this front for the USD suggest a 10% appreciation

would trim roughly 0.5% of CPI after one year.

This degree of sensitivity matches the ready

reckoners calculated by the OECD. In other

words, it might take a 20% move in the USD to

exact a sizeable hit on US inflation projections.

However, given the decline in oil prices, forecasts

for headline inflation are already on the retreat. So

while there is clearly some more room for the

USD to strengthen before it would begin to have a

sizeable impact on US core inflation projections,

it will become more of a consideration in terms of

the pace of US tightening.

How broad will the USD rally be?

If we believe that a 20% USD rally would not be

untoward in terms of the scale of the move, the

other consideration is how broad-based the rally

might be. Since the broader USD rally began to take

hold in July 2014, the greenback has risen against

all 33 of the world’s most actively currencies.

11. A 20% USD rally would not be extraordinary

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DXY

19% 16% 24% 21% 19%24% 15% 25%95% 51%


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But while these currencies have fallen against the

USD, some have fallen relatively modestly. These

include the IDR and INR, currencies which were

traumatised in 2013 by the prospect of US

monetary tightening. Improvements in economic

and political fundamentals in India since then

might argue for greater resilience to the prospect

of higher US policy rates. However, it is likely

that the comparative stability in the US treasury

market this time has helped prevent too much

trauma for the IDR and INR, and emerging

market FX in general.

Chart 13 shows an index of the ‘fragile five’

currencies (INR, IDR, BRL, ZAR & TRY)

against the USD plotted against US 10Y Treasury

yields. The relationship had been fairly strong

from 2013 until September 2014 although it has

broken down recently. G10 currencies seem more

fixated on the differential at the very short end of

the curve, whereas EM FX seems more fixated on

10Y yields. We do not expect US 10Y Treasury

yields to rise over the next year, which should

limit the damage to EM FX. But if US yields rise

sharply, then EM FX will be very vulnerable, and

USD strength will change into a surge.

Of course, one side effect of a stronger USD

should be lower imported inflation. In turn, this

could help temper any upward pressure on US

yields, reducing the risk that EM FX will face the

same kind of trauma as in 2013.

Conclusion

The USD bull run has further to go. A year ago

we suggested that USD strength would be the

dominant theme in currency markets during 2014,

a view vindicated as the USD was the world’s

best performing currency. We expect a repeat

performance in 2015. Our forecast of additional

USD gains may not be enough to push inflation

back to target in those countries struggling with

the deflation threat, but it could buy them time

and help prevent inflation expectations becoming

permanently detached from target. Our forecast

pace of USD strength suggests it will be a helpful

development for others.

12. The USD's dominance has been absolute 13. EM FX is vulnerable to any rise in US yields

-45.0-40.0-35.0-30.0-25.0-20.0-15.0-10.0-5.00.0

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RUB

NOK

BRL

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ZKEU

RM

YRG

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RAR

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NY

Performance v s USD since 1 July

EMEA Performance Asia PerformanceLatAm PerformanceG10 Performance

%%

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3.1

96100104108112116120124128132

Jan-13 Jun-13 Nov-13 Apr-14 Sep-14

Weighted index of the "Fragile 5" since Jan 2013 (equally-weighted, 100=1 Jan 13) (LHS)US 10 Year Treasury Yield

%


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2015: The FX year of living dangerously

The FX market’s consensus view of the world is

that the JPY will weaken sufficiently to help bring

the Bank of Japan’s inflation rate closer to target,

but not so much as to de-stabilise wider

confidence in the JPY. Similarly, the EUR is

expected to depreciate, helping to head off the

Eurozone’s deflation threat, but without falling so

far or so quickly as to reignite questions over the

currency’s longer-run viability. The flipside to

this is a forecast of USD strength, but not

excessive appreciation that would prevent the Fed

from beginning the process of interest rate

normalisation in 2015, or that could prompt an

emerging market FX crisis. The suggestion that

the FX world can muddle through is one which

faces many challenges, and we believe some

account of the tail risks faced needs to be woven

into base case forecasts. This points to an even

stronger USD.

This report is divided into three sections:

1. The threats to the market’s “muddle

through” scenario

2. The argument for a policy accord with a

look at past currency accords

3. What does it mean for our forecasts?

1) The threats to the market’s “muddle through” scenario

The risks confronting the currency market now

carry particularly large consequences for the

levels of exchange rates. We are back to the era of

needing to contemplate tail risks. Even if we

believe the probability is small, some account has

to be taken in our forecasts for the possibility

these risks come to fruition. We examine three

potential sources of risk, first in Japan, then

Europe, and finally within emerging markets.

A) Japan loses control of the JPY

Since the emergence of ‘Abenomics’ at the end of

2012, the Yen has weakened by one-third on a

trade-weighted basis. It has been a currency

realignment driven by monetary policy, hopes for

structural reform, and occasional bouts of short-

term fiscal stimulus. The decline in the Yen has

been mostly orderly, and policymaker rhetoric

generally reflected an understandable comfort

with not only the direction but also the pace and

volatility of the shift. With a USD-JPY consensus

How extreme USD strength can destroy the world

15


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projection of 124 for year-end 2015, this well-

mannered adjustment is anticipated to continue.

Yet it is entirely plausible that the Yen decline

becomes disorderly and swift. The flow diagram

in chart 1 shows the possible drivers and

outcomes. To begin, we consider three possible

catalysts that could challenge the consensus, and

drive a debasement of the Yen.

i) The BoJ loses its grip on the Yen as market

anticipates aggressive future QE:

Since the reflex reaction of the central bank to a

failure of QE to deliver sufficient inflation is to

throw ever more QE at the situation, the risk is

that investors will begin to value the Yen based on

a succession of anticipated additional aggressive

easing moves. This could see the currency weaken

swiftly as investors question the future value of

the Yen, prompting capital flight as investors buy

overseas assets, most likely in hard USD. The

central bank would fight to stop the rot, perhaps

even by reversing QE. This could succeed, but if

this failed, it could create an explosive move

higher in USD-JPY.

ii) Expectations for fiscal largesse and

monetisation drive a much weaker Yen:

An alternative policy over-shoot scenario could

come from the fiscal side of the equation. The

latest fiscal stimulus plan targets consumers. If

supporting household spending becomes the

favoured tactic, the temptation to drift towards

increasingly generous fiscal programmes could

grow. We do not expect a ‘helicopter drop’ of

income into every household, but the Yen would

react very badly to any sign that the government is

heading down a route of overt monetisation of

fiscal policy. There are many obstacles to this

outcome, including Kuroda’s likely resistance,

and it would likely require a change to the BoJ

law to reduce the central bank’s independence.

But in an economy where growth and inflation are

shy of expectations, the market cannot entirely

rule it out.

iii) Successful Abenomics drives market

expectations for ‘more of the same’ regarding

Yen weakness, while failure might drive

capital flight:

Our first two scenarios whereby the Yen weakens

excessively rely on the policy reaction to failure.

But it is possible the Yen weakens in response to

policy success. Wages growth could finally pick

up, supporting consumer spending in a lasting

way, and pushing underlying inflation higher,

1. How the decline in the Yen could become disorderly

Aggressive monetary ease Aggressive fiscal ease Successful Abenomics

JPY debased

Corporate Japan cuts export prices

Capital flight Stronger USD

TranslationTransaction/ market share

Currency war intensifies

China responds

Effective US response

No Yes

No

Cause

Result

Effect

Source: HSBC

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which supports even swifter wages growth in

Japan’s tight labour market. This wage-inflation

spiral would likely be viewed as reflective of

Abenomics’ success, but it could still lead to a

view that the Yen should be weaker alongside

rising inflation expectations. Alternatively, one

could also argue that any ultimate failure of

Abenomics could also deliver Yen weakness if it

provoked a capital flight out of equity markets

and bonds. Might all roads lead to Yen weakness?

The repercussions of a debased Yen.

If there are three main channels through which we

could see a collapse in the Yen, there are also

three main channels through which it could

influence other currencies. All are tied to the

wider issue of currency war, and we examine each

in turn here.

i) Corporate Japan’s response:

One notable characteristic of Japan’s efforts to

weaken the Yen is that it has not drawn the rest of

Asia into the currency war. True, the KRW and

TWD have weakened against the USD, but not

because of direct efforts of their policymakers to

match Japan’s tactics. Both currencies have

appreciated significantly against the Yen since

the onset of Abenomics, the KRW by 60%, the

TWD by 45%.

2. Korea’s exports volumes have long outpaced Japan’s… 3. …even since the start of Abenomics

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Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

JapanKorea

Jan 2008=100,3 month MA (sa)


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96

98

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Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14

KoreaJapan

Jan 2013=100, 3 month MA (sa)


Source: CEIC, HSBC Source: CEIC, HSBC

4. There are already signs that Japan’s exporters are belatedly responding to the weaker Yen

96.0

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Export prices Japan (local currency) Export prices Korea (local currency)Jan 2013=100 Jan 2013=100

Source: CEIC, HSBC

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Yet as chart 2 and 3 show, this sizeable relative

currency shift has not resulted in a loss of

market share for Korean exporters, for example.

Export volumes continue to comfortably outpace

those of Japan.

In the early stages of the Yen’s decline, Japan’s

corporate sector chose not to cut export prices

(see chart 4). One explanation for this reticence

was reportedly that exporters were not confident

the Yen’s weakness would persist. As a result, the

benefit of a weaker Yen came through the

translation effects on Japan’s corporate sector’s

profit, rather than the transaction effect on rising

volumes and market share.

There are signs in the last few months that this

attitude is changing with Japanese export prices

falling. Perhaps the export sector is adjusting

belatedly to Yen weakness. In an environment of

a rapidly declining Yen, the temptation to boost

market share would be even greater.

This could change the nature of the currency war

in Asia. The need for policymakers elsewhere in

the region to fight a potential loss of market share,

in what is already a challenging export market,

would grow. Korea and Taiwan might become far

less tolerant of their currencies strengthening

against the Yen under these circumstances, and

the tentacles of the currency war would spread.

ii) China’s FX policy response:

The bigger question, however, is whether a more

combative Japanese export sector would draw

China into the currency war. China has not yet

joined the currency war, and we do not think it

likely. For this to change would require a very big

move in the Yen, and perhaps an explosive one.

There are some grounds to argue that China

would join the currency war and devalue the

RMB if currency moves elsewhere became

disorderly. Activity has been softer than expected,

and inflation is currently running at only half its

target level. If other currencies in the region were

to become unanchored from the USD by virtue of

a rapidly declining Yen, it would complicate

economic policy choices for China. The RMB’s

nominal effective exchange rate would appreciate

more rapidly than before, creating a further

headwind to inflation. Lower nominal GDP

growth could raise questions over debt

sustainability, while the corporate sector could

feel squeezed by higher real rates. The temptation

to realign the RMB would be greater.

5. China’s REER and NEER

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CNY NEER CNY REER2010=100 2010=100

Source: BIS, HSBC

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However, we believe the hurdle to any such

reaction in China is very high. China’s FX policy

is centred on reform and rebalancing the economy

alongside the internationalisation of the currency.

A competitive devaluation would be very

damaging to this process. In addition, China also

recognises its role as an anchor for the region, and

a big shift in the RMB would be extremely

destabilising for Asia’s economy.

A much weaker RMB could also trigger hot

money outflows from China, complicating

management of the balance of payments. Thus,

devaluation would be a last resort, with rate cuts,

reductions in the reserve requirement, and maybe

QE more likely to be tried first.

Nonetheless, the threat that China could become

embroiled in the currency war, however low a

probability one chooses to attach to it, could be the

real significance of a rapid weakening of the Yen.

In the world of trade, China’s involvement or not

in the global currency war is of far greater

significance than that of Japan (chart 6). For more

see ‘Asian FX Focus: 2015 Outlook: The pressure

cooker’, 08 December 2014.

iii) The US response

The flipside to our scenario of pronounced Yen

weakness would be a stronger USD. If Yen

weakness was the result of a loss of control of the

currency by Japan’s policymakers, the most likely

destination for the capital flight out of Japan would

be the US. The EUR would be an alternative insofar

as it offered the same kind of scale and liquidity as

the USD, but given its central bank would likely be

in the middle of a QE programme of its own, its

appeal to investors fleeing monetary excess in Japan

would be limited.

We have argued previously that the tolerance of

US authorities for USD strength would hinge on

the ability of the US economy to generate enough

inflation internally to withstand importing

deflation from elsewhere. But in an environment

of a rapidly declining Yen, it is questionable

whether the US could fight against the

appreciation of the USD successfully. If the RMB

were also to weaken against the USD, USD

strength could be even more problematic given

the US’s far greater exposure to China trade than

to Japan’s trade. The RMB’s share of the USD

broad index is 21%, compared to 7% for the Yen.

6. China’s policy matters far more than Japan’s in the context of the currency war

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% %Global export market share

Source: UNCPAD, HSBC

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=3Wgn4S22qA&n=440494.PDF

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The US has not named a country as a currency manipulator for 20 years

The US Treasury is responsible for determining whether foreign economies manipulate their currencies against the USD, “for

purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international

trade,” according to Section 3004 of the Omnibus Trade and Competitiveness Act of 1998. The Treasury has designated several

countries as currency manipulators since the statue took effect, including Taiwan (1988-89, 1992), Korea (1988-89) and China

(1992-94). No country has been named since 1994, but there have been several periods since when countries were deemed at

greater risk of being named, including Japan in the mid-1990’s, and China at various times since 2000.

There are a host of factors that Treasury considers in the decision to designate a county a currency manipulator but the key tenets

of the authorizing statute focus on balance of payment adjustments and competitiveness. Two key benchmarks are the country’s

overall current account balance and its bilateral trade balance with the US. Hence, countries with large current account

surpluses, which run large trade surpluses with the US, and which employ policies that can specifically impact the exchange rate

(FX intervention or other) are more likely to be considered. Economic conditions as well as capital flow analysis, are also

considered. These all form the basis for the Treasury’s semi-annual report to Congress on exchange rates.

In reality, naming a country as a currency manipulator has political considerations. US firms and industries who feel they are

being disadvantaged by the exchange rate or trade policies of other countries often bring those concerns to Congress and/or the

Treasury. Indeed, from 2004 until as recently as 2011, there have been a number of Congressional efforts to advance legislation

that would impose various putative tariffs on China if it did not allow the RMB to appreciate more against the USD. In effect,

they represented an effort to circumvent the Treasury’s authority in exchange rate policy, and were deemed necessary by their

Congressional sponsors because Treasury had failed to name China a currency manipulator.

Those past legislative efforts never became law. But similar efforts in the future are likely to be an important feature of an

increase in currency tensions between the US and other countries, for several reasons. First, the authorizing statue for the

Treasury does not define specific consequences for countries named as manipulators. Instead, it stipulates that Treasury, “take

action to initiate negotiations…on an expedited basis…for the purpose of ensuring that such countries regularly and promptly

adjust the rate of exchange between their currencies and the US dollar to permit effective balance of payments adjustments and

to eliminate the unfair advantage.” In China’s case, such negotiations have been going on for years, and have included a

permanent Treasury attaché to China, and the US-China Strategic and Economic Dialogue. Moreover, no country has been

named a currency manipulator for 20 years, demonstrating that the bar is high. Congress has attempted to act when Treasury has

not. It can define and authorize specific penalties if a country is designated a manipulator. Or, as past legislation has attempted,

it can define the action required by China (the degree of currency appreciation versus the dollar) and the penalties to be applied

if that did not occur.

Some members of Congress claim that these legislative efforts, even without passing, were more effective than Treasury’s

actions in encouraging China allow the RMB to appreciate since 2005, in large part because of their punitive nature. That is a

somewhat simplistic assessment of a very complicated matter. But it suggests that in the future, if certain interests in the US

become less comfortable with USD strength, stepped up legislative efforts in Congress as well as increased scrutiny by the

Treasury will be the initial responses.

It is also important to differentiate the considerations and policy responses between the Federal Reserve and the US Treasury to

dollar strength. The Treasury determines dollar policy and the discussion above centres on the US political response to USD

strength. But the Federal Reserve could alter its policy path in response to a stronger USD, which might involve limiting or

delaying rate hikes to offset the tightening in monetary conditions associated with the currency’s appreciation. In that respect,

the Fed policy response is a reaction to its assessment of the economic fallout and impact on monetary conditions from USD

strength, rather than the more politicized considerations of the Treasury and Congress.

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For the US Federal Reserve, the immediate

implication would be to delay the start of the rate

tightening cycle, but the real concern would be

whether a fresh bout of quantitative easing would

be adopted. The idea of QE4 may sound peculiar

for a market currently gauging when interest rates

are about to go up, but it is worth remembering

that when QE1 finished, QE2 was not expected.

When QE2 finished, further QE was also not

anticipated. QE4 could be a legitimate reaction to

excessive USD strength.

But even QE4 might not stem the rally in the USD

if the Yen were sliding uncontrollably. Lower

rates for longer in the US would be positive for

US growth, potentially supporting US assets.

It is also questionable whether the US Treasury

would be able to mount an effective counter-

offensive. It has long argued the merits of a strong

USD, and we suspect the administration in its last

two years would struggle to define and implement

an about-face on this mantra. There could be

official criticism of China as a currency

manipulator were Beijing to join the currency war

(see box on previous page) but the impact on the

USD would be minimal.

B) Reignited European break-up fears

There is an alternative route to excessive USD

strength, but one which is rooted in Europe rather

than Asia. The commitment of Draghi to “do

whatever it takes” provided the circuit breaker to

prevent the sovereign crisis in the Eurozone

feeding on itself. Given the resultant OMT

remains in place, the assumption is that the threat

of a peripheral crisis or EUR break-up is now

consigned to the past.

The danger, however, is that the threat of a

flare-up of sovereign concerns is non-zero. This

comes from two potential sources:

i) A more Eurosceptic political landscape

ii) Reduced economic downside of exit

Any heightened concerns about break-up, either

of the Eurozone or the wider EU, will be most

acutely reflected in the exchange rate rather than

the bond market, where ECB buying could still

cap yields. EUR weakness would be the safety

valve through which market concerns would be

expressed (see chart 7).

7. The flare-up of Eurozone sovereign concerns could play out like this

UK EU/EUR

May 2015 General Election Rising euro-scepticismStronger fiscal position in

periphery

EU in-out referendum Political will for unity declines Ability to leave rises

EUR USD JPY

Asian FX war?

Source: HSBC

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1) A more Eurosceptic political landscape

The political popularity of the EU and Eurozone

has been waning recently, illustrated by the rise of

the Eurosceptic parties in the 2014 elections.

Chart 8 illustrates the rise of some of these parties

since the 2009 elections. The UKIP in the UK, the

National Front in France, and SYRIZA in Greece

all came out on top in their respective elections

with an average increase in vote of 16.8%.

This swing illustrates the disillusion many are

feeling about the EU. The biannual Euro-barometer

survey echoes the decline in perception of the EU.

Respondents were asked “In general, does the EU

conjure up for you a very positive, fairly positive,

neutral, fairly negative or very negative image?”

The percentage of those polled ‘positive’ about the

EU has fallen from its high of 52% in 2007 to its

current level of 35% (see chart 9).

It is a shift in mood that carries implications for

the mainstream parties also, as they have to bear

this euro-scepticism in mind when drafting their

own manifesto. In the UK, for example, this rise

in Eurosceptism has led to the Conservatives

announcing there would be an EU ‘in-out’

referendum in 2017 if they are re-elected as

government in the May 2015 election. The

implications for GBP of this political uncertainty

could be very negative (see ‘Currency Weekly:

The ABC of further GBP weakness’,

27 November 2014), but it would also have

potential repercussions for the wider stability of

the EU and the euro project. Were the UK to be at

risk of leaving, it would remind markets that

membership of the EU and the euro project is not

necessarily a one-way street.

In addition, the political support across the

Eurozone for Draghi’s promise to protect the euro

project is a central part of its legitimacy. In many

respects, the firepower thrown at defending the

single currency was driven by political rather than

economic considerations. The threat for 2015 is

that the shifting political landscape towards

greater euro scepticism will raise questions over

the extent of that support.

2) Reduced economic downside of exit

The first risk is that the political will to protect

EU and Eurozone unity may be on the retreat. The

second risk is that the cost of leaving may not be

so onerous now as it was in 2012. For example, in

the case of Greece, the central bank warned that

per-capita income would fall by more than half,

unemployment would soar, and inflation would

push to 30%. Some of these projections could still

hold today, but one factor that held back ‘exit’ is

not so prominent.

8. Eurosceptic parties are enjoying a greater following 9. The EU population is less enthusiastic about the EU

0

5

10

15

20

25

30

0

5

10

15

20

25

30

UKIP(United

Kingdom)

NationalFront

(France)

SYRIZA(Greece)

Five StarMovement

* (Italy)

Alternativefor

Germany *

2009 European Election 2014 European Election% of v ote % of v ote

25

30

35

40

45

50

55

25

30

35

40

45

50

55

Apr-06 Apr-08 Apr-10 Apr-12 Apr-14

% of population who view EU as positive% %

Source: Wikipedia, HSBC (* New party so did not take part in 2009 elections) Source: Standard Eurobarometer 81 Spring 2014, HSBC

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=vMUUGQ81se&n=439780.PDF

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In 2012, the peripheral countries of the Eurozone

ran sizeable primary fiscal deficits. This meant

that even if they reneged on their debts had they

left the Euro and therefore did not have to pay any

interest on their loans, they would still not have

enough revenue to run the government. Given that

capital markets would most likely be closed to

them in this scenario, it suggested the state would

not be able to operate. Italy and Portugal already

ran a primary surplus in 2013. Ireland is expected

to run a primary surplus in 2014, and Greece

expects to run a primary budget surplus of 3% of

GDP in 2015. Only Spain still falls short.

The EUR would be the safety valve

Our aim here is not to suggest the EU or the

Eurozone is about to break-up. It is simply a

reminder that the market cannot rule this tail risk

out entirely just because the ECB has put the

OMT in place. But the presence of the ECB’s

bond back-stop programme means that any

heightened risk of break-up is unlikely to be

reflected in a blow-out in peripheral bond yields

in the manner seen during 2012. Any ongoing QE

programme would add to the compression of

yields. Instead, the currency is likely to be the first

point of least resistance when factoring in any

break-up risk. The EUR needs to reflect the exit

risk in 2015, and additional USD strength is again

the likely echo of this EUR weakness.

EUR exit fears would heighten the risk of an

Asian currency war

The USD bid that any break-up fears in Europe

might conjure up would presumably be echoed in a

higher USD-JPY rate. In turn, this could foster the

descent into a more destabilising currency war in

Asia, the risk of which we detailed in section A of

this report. The two risks are therefore inter-twined.

C) Excessive USD strength provokes an EM FX crisis

If the risk of European break-up and an Asian

currency war are related, so too is the possibility

of an emerging market FX crisis. While we think

the bar is very high before China would be

tempted to devalue its currency, any such move

would have massive repercussions not just for the

rest of Asia but for EM FX in general. It could

prompt a race to the bottom through competitive

devaluations, or a retreat from risk assets in

general amid heighted market uncertainty.

Similarly, elevated fears of break-up in Europe

could prompt risk aversion with damaging

implications for EM FX. The market would also

need to cope with the spectre of an excessive USD

10. Much of the periphery now runs a primary budget surplus

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0

5

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-5

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5

Greece Ireland Italy Portugal Spain

2010 2015 (projected)% of GDP % of GDP

Source: European Commission, HSBC

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bull run triggered either by the debasement of the

JPY, or questions over the longevity of the EUR.

Of course, it is not all doom and gloom for EM

FX. US short-term rates would likely remain low

for longer were the USD on an uncontrollable bull

run. Long-term Treasury yields would presumably

be compressed by safe haven inflows, reduced US

inflation and the allure of an appreciating USD.

Unconventional policy easing in Europe and

Japan would add to the liquidity pool available to

EM, as could any QE4 initiative from the US in

response to a stronger USD.

Nonetheless, EM FX has shown it is not

impervious to a bullish USD in 2014, whatever

local merits an economy might offer. The global

situation is largely overwhelming local factors,

even if some occasional relative opportunities

become apparent. If the global backdrop were to

transform into far more aggressive USD moves in

2015, the possibility of de-stabilising knock-on

effects for EM FX would grow. It is another risk

that investors will need to account for.

2) The argument for a policy accord

Reaching the limit of currency policy

In section 1, we outlined three of the key

vulnerabilities we see for the global currency

market in 2015.

In part at least, these problems stem from the fact

that monetary policy is reaching its limits. At the

outset of the crisis, interest rate cuts were

delivered to try and stem the rot. In cases where

the zero bound was met, central banks were

forced down the route of unconventional easing in

its various forms. The initial aim of this strategy

varied somewhat, but in general it sought to keep

interest rates low and help the transmission of

monetary policy. But with yields now at multi-

year lows in many countries, it is clear that we

may have reached the limits of QE also.

This has fostered a renewed focus on currencies

as the transmission mechanism of monetary

policy. The ECB might argue that it does not have

an exchange rate target, but it is clear that EUR

weakness is a key element of its current easing

strategy. Japan’s policymakers have been far more

overt in their push for a weaker JPY. With the

exception of the US, other developed nations have

also expressed a preference for currency

weakness. But the danger for 2015 is that, like

interest rate cuts and QE before it, the use of

currency as a tool of economic management may

be reaching its limit.

From Plaza to Louvre to the new accord?

“I come now to talk of new and different battles

we must fight together, to speak of a global

economy in crisis and a planet imperilled. I say

we should seize the moment, because never

before have I seen a world so willing to come

together. Never before has that been more

needed, and never before have the benefits of

co-operation been so far reaching.”

UK Prime Minister Gordon Brown in the run-up to the G20 London Summit 2009

Our three vulnerabilities point to a potential

unravelling of the currency market. The

possibility that Japan could lose control of the

Yen and trigger a destabilising intensification of

the currency war, or that Europe could lose

control of the EUR through heightened break-up

fears, or that EM FX could face fresh trauma all

argue for some co-operation to head off the threat.

Currency markets have shown themselves adept at

co-operation. The Plaza Accord of 1985

successfully reversed the earlier rise of the USD,

so much so that a subsequent Louvre Accord was

required in 1987 to arrest the USD’s decline.

These were examples of direct intervention in the

FX market to achieve a co-operative solution.

Given the risk of a destabilised currency market in

2015, the case for collaboration has returned.

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Perhaps a Honda Accord could be the vehicle to

deliver this teamwork.

One radical co-operative step could be a

programme of debt monetisation. The Fed could

agree to write off a portion of the Treasuries it

holds, the BoJ likewise with its JGBs and the

ECB with its balance sheet also. This

monetisation would leave governments more free

to offer fiscal stimulus. The impact on G3

currencies relative to each other would be

contained as each economy would be adopting a

similar tactic. Only those outside of the accord

would see their currencies sharply appreciate. It

could incentivise others to co-operate also. For a

more detailed look at historic accords see ‘What

would it take to get a new currency accord?’.

Clearly, there are many political and possibly legal

obstacles to any such accord. We address these in

more detail later in this document. But the threat of

an unravelling FX market warrants something

radical. In all likelihood, however, policymakers

are unlikely to act to head off a currency market

crisis. An accord might prevent a crisis, but a crisis

may first be needed to force an accord.

3) What does it mean for our forecasts? There will inevitably be differences of opinion as

to the likelihood that the risks we have

highlighted actually occur. However, it is clear

that some account should be taken of these tail

risks, as their potential impacts could be so large.

In the case of EUR break-up, the market has some

recent precedent about how to approach this

possibility. News that increased the likelihood of

‘Grexit’ in 2012 and 2013 would encourage you

to sell the EUR even if, ultimately, you believed

the EUR would remain intact. It was simply that

the probability of disaster had risen.

A similar mind-set can be adopted this time around

for our three risks of European break-up, an

unravelling of the currency war, or fresh ordeals for

EM FX. The repercussions of all three risks are

generally for a stronger USD, and the forecast

revisions we have made over the last month have

been for a stronger USD to reflect these tail risks.

We were bullish on the USD in 2014 and it

proved to be the best performing currency. For

2015, Chart 11 shows the result of our various

forecast changes. The pattern is clear. We once

again expect the USD to be the dominant

performer, outstripping all comers.

11. USD to be an outperformer in 2015

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Forecast spot return in 2015 %%


25


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Conclusion

The consensus view of the FX world is

understandably fixated on the monetary tug of war

currently in play in developed markets. It is also

the dominant element to our forecasts for USD

strength. However, the consensus projections

suggest all currencies can muddle through this

monetary transmission, the EUR and JPY a little

weaker, the USD a little stronger. But the risks of

destabilising moves in the currency market are

growing on a number of fronts, both in Asia and

in Europe. It could drive a surge higher in the

USD that US policymakers would be powerless to

prevent. The implications for EM FX would be

potentially problematic.

Cooperation via an economic accord could head

off these risks to the currency market, but it is

more likely that a crisis will first have to happen

before policymakers are forced into action. In the

meantime, we believe it prudent to factor in some

element of these FX tail risks to our central case

forecasts for 2015 and 2016.

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As we have described in the previous part of this

document, there is a risk that the dollar rally

accelerates in 2015 either because the yen falls

rapidly as Japan intensifies Abenomics or because

the long-term future of the euro comes under

renewed scrutiny, or both. In either case dollar

strength could also be exacerbated by an EM

currency crisis.

The economic consequences of a further slow and

modest dollar rally may well be beneficial for global

growth, as it would help revive activity in Japan and

the Eurozone without undermining the US recovery

too much. However, a very large and rapid further

dollar rise could be malign in that it would

undermine the US economy while being driven by a

loss of confidence in Europe and/or Asia.

One way of avoiding this negative outcome would

be for major governments to come to an agreement

to act to prevent the rise in the dollar becoming too

extreme. International agreement on currency

cooperation has been seen before and we explore the

conditions that led to the 1985 Plaza Accord to

weaken the dollar to see what might be required to

reach a new agreement should the dollar rise

accelerate in 2015.

Our conclusions are that a new agreement on

currency cooperation is very unlikely without a

new crisis, and that any new accord would have to

consist of more than merely an agreement to

intervene in the FX market to try to stem the

dollar’s rise. Reaching any new accord will likely

be much more difficult than it was in 1985 given

divergent policies and the much wider group of

What would it take to get a new currency accord?

1. The dollar rose by 90% between 1980 and 1985 2. Tight monetary policy pushed short and long term US rates above other major countries

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Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85

DXY

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Jan-

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84

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85

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Short term money spread10 year bond spread %%

Interest rates spreads - USD versus other major currencies

Source: Bloomberg, HSBC Source: US Treasury, OECD, HSBC

27


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countries that would now be involved in

negotiating an agreement.

The rise of the dollar 1980-1985

Between 1980 and 1985 the dollar rose by about

90% on an index basis (chart 1), with USD-JPY

moving from about 200 to a high of 280, and

USD-DEM rising from 1.75 to 3.45. The high for

the dollar against the yen came well before the

high for the dollar against European currencies, so

the overall move in the dollar was not as great as

the moves against individual currencies. The

move also included periods of severe EM

weakness, especially in Latin America.

The rise in the dollar was driven by three main

factors:

1. Tight monetary policy

In October 1979 new Fed Chairman Volker

announced that the Fed would now target bank

reserve growth (and hence money supply growth)

rather than the Fed funds rate. Fed control was

enhanced by the Monetary Control Act of 1980

which imposed reserve requirements on all

deposit takers, not just banks. US short-term

interest rates surged and the oil price induced

recession of 1980 became the deep ‘double dip’

recession of 1981/82. Inflation fell, and by 1983,

it was back below 5%.

Chart 2 shows US short and long-term interest

rates relative to a basket of rates in other major

economies (Japan, Germany, UK and Canada).

US short-term rates went as much as 700bp above

the basket in 1981 and both long and short-term

rates averaged about 300bp above the basket until

late 1982. The scale of the interest rate advantage

enjoyed by the dollar was probably the major

driving factor in the early part of the dollar’s rally.

2. The Latin-American debt crisis

The oil price rises of the 1970s transferred

resources from oil consumers to oil producers.

The newly rich oil exporters looked to invest their

wealth and US banks saw a big increase in

overseas deposits. They, in turn, were encouraged

to recycle these ‘petro-dollars’ by lending to Latin

American governments who were building their

domestic infrastructure (chart 3). By the early

1980s, however, with much higher US interest

rates many of the loans were being used to pay

interest on existing loans rather than to invest in

infrastructure. Total outstanding debt from all

sources in Latin America increased from USD

29bn in 1970 to USD 159bn in 1978 and to USD

327bn in 1982.

In June 1982 Mexico announced that it would no

longer be able to service its debt of USD 80bn.

Other countries quickly followed suit and

3. The LatAm Debt crisis reduced the supply of dollars 4. Fiscal expansion supported US activity

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1977 1979 1981 1983 1985 1987 1989

Total Outstanding LDC Loans by the 8 largest US Banks USD bn USD bn

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1977 1978 1979 1980 1981 1982 1983 1984 1985 1986

US Federal Budget Balance (% of GDP)

Source: US FDIC, HSBC Source: White House, HSBC

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ultimately 16 Latin American countries sought to

reschedule their debts. As a result of this US

banks effectively stopped lending overseas and

the supply of dollars in the international markets

was severely reduced. This gave the dollar

additional strength as non-dollar assets were sold

to obtain the dollars needed for debt servicing.

3. Expansionary fiscal policy

With the Fed’s tight monetary policy an important

driver of the 1981/82 recession, President Reagan

significantly eased fiscal policy in 1982 and 1983

by cutting marginal tax rates to try to revive

growth. The US fiscal deficit increased from

about 2% of GDP in 1981 to nearly 6% of GDP in

1983 (chart 4).

The impact on US activity was very powerful.

After a fall of 1.9% in 1982, GDP grew by 4.6%

in 1983 and by 7.3% in 1984. The short and long

term interest rate advantage enjoyed by the dollar

began to rise again and stood at nearly 400bp in

mid-1984 (chart 2 again).

The consequences of the strong dollar

The rise in the dollar put the US manufacturing

sector under great strain as it was increasingly

unable to compete against goods imported from

overseas, especially Japan. There was also

concern that the inflow of overseas investment

risked the ownership of important US assets going

abroad. An increasingly vocal campaign made

Congress consider protectionist legislation, and

because of this President Reagan began

negotiations with Japan and Europe to weaken the

dollar through joint intervention in the FX market.

By the time the agreement was reached (the Plaza

Accord of September 1985) the dollar had already

peaked as the market became less willing to

finance the then record US current account deficit

of 3.5% of GDP. The agreement was a success in

the sense that it accelerated the decline in the

dollar, though it did little to reduce the US trade

deficit with Japan which was the main concern of

the lobbyists.

The communique issued by the G5 finance

ministers and central bank governors included the

following two sentences:

“They believe that agreed policy actions must be

implemented and reinforced to improve the

fundamentals further, and that in view of the

present and prospective changes in fundamentals,

some further orderly appreciation of the main non-

dollar currencies against the dollar is desirable.

They stand ready to cooperate more closely to

encourage this when to do so would be helpful.”

This was the only new agreement; the rest was a

restatement of policies already put in place by the

respective governments. However, it was certainly

very effective in that the dollar unwound all of its

1980-85 rise over the next two years.

How far are we from a currency accord?

Three main factors can be identified which led to

the Plaza Accord. We now look at each of these in

turn to see how close we are to conditions that

may lead to a new accord.

1. The dollar’s rise was extreme and protracted

The 90% rise in the dollar against other currencies

between 1980 and 1985 was unprecedented in the

floating exchange rate era and confounded the

conventional wisdom of the time that the

widening US current account deficit would see it

fall back. This time round the dollar has so far

risen about 10% since its rally started and about

20% from its 2011 low, so the move has not yet

been as protracted or as extreme. In terms of price

levels we would need to see USD-JPY at 150 and

EUR-USD below parity for the current rally to be

on the same scale as the 1980-1985 rise. We are

therefore probably still a long way away from a

currency accord in both time and price.

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2. The rise in the dollar had a significant

negative economic impact on the US

The main motivation behind the Plaza Accord from

the US side was concern that the US Congress was

becoming much more vocal about the damage

being done to domestic industry from imports and

was preparing protectionist legislation. As can be

seen in chart 6, the US balance of trade in goods

had been in only a small deficit in the early 1980s,

but by 1984 it was running at an unprecedented

USD 30bn per quarter. Significant damage had

been done to US manufacturing by the 1981/82

recession and the strong dollar was seen as another

major damaging factor.

The rise in the dollar since 2011 has not yet had a

discernible negative effect on the US economy.

The current account deficit has actually been

shrinking despite the outperformance of the US

economy as the shale oil boom reduces oil

imports and the surplus on the trade in services

has grown.

A further sharp rise in the dollar could undermine

the US recovery, but the US authorities would

probably first prefer to use domestic policy

options (such as delaying rate increases, or even

QE4) before trying to get international agreement

on a new currency accord.

3. There was sufficient international policy

agreement that all could benefit from a

lower dollar

A crucial factor behind the Plaza Accord was that

there was sufficient international agreement that

all could benefit from a lower dollar. While the

US would obviously hope to see its trade balance

improve as a result of a weaker currency, Japan

and Europe expected that a rise in their currencies

would bear down on inflation and allow lower

interest rates which would encourage growth in

the domestic economy even if exports weakened.

In the event, short-term interest rates outside the

US did fall significantly in the two years after the

accord. Chart 7 shows short term interest rates in

the US and in a weighted basket of overseas

economies (Japan, Germany, France, Italy,

Canada and the UK) between 1985 and 1987.

From around 7.5% in mid-1985, short-term rates

outside the US fell to around 5.5% by mid-1987.

5. Since the 2011 low, the USD has risen by only 20% so far 6. The US trade deficit widened sharply in the early 1980s

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0 200 400 600 800 1000 1200

1980-1985 2011-2015USD Index (Fed measure, major currencies)

low =100 low =100

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US Trade balance in goodsUSD bn USD bn

Source: Bloomberg, HSBC Source: US Treasury, OECD, HSBC

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In the current circumstances there are not the

opportunities to offset currency strength with

domestic policies that there were in 1985. With

both fiscal and monetary policies at or near their

limits in many countries, the exchange rate has

itself become a policy instrument. Exchange rates

are now much closer to a zero sum game – the

country with the falling exchange rate exports

deflationary pressures to the country with the

rising exchange rate.

As long as there is perceived to be little

opportunity to offset currency strength with

domestic policies it will be difficult to get

international agreement on a currency accord

unless there is a severe crisis.

The Plaza Accord of 1985 was possible because

the US had a strong incentive to negotiate it, and

the other countries could see the benefits of it

being put in place. As things currently stand we

are a long way from either of these conditions

being fulfilled, so, in the absence of a severe

crisis, it is very difficult to see a new accord on

exchange rates being reached.

What might a new accord look like?

Should the rise in the dollar be rapid and extreme

enough to endanger global economic stability,

then there would certainly be an incentive for

governments to try to coordinate policies to halt

or reverse it. However, any such new agreement

would have to be very different form the Plaza

Accord. That agreement was essentially no more

than to intervene in the FX market and the dollar

was already beginning to decline by the time the

agreement was reached.

This time an agreement to intervene would almost

certainly not be enough for two reasons.

1. Domestic monetary policy is very different in the

US to those in Europe and Japan and intervention

would run counter to existing policies.

2. As we have already argued, foreign exchange

moves are now much more of a zero sum game

than they were in 1985, so it would be much more

difficult to get agreement on moves to reverse the

dollar’s rise.

Any new agreement would have to include

measures other than FX intervention and would

probably have to cover financial stability, trade

policy and market regulation. However, reaching

any sort of agreement is likely to be much more

difficult now than it was in 1985. The forum for

international agreements is now much larger than

it was in 1985. The G5 has become the G20, and

it automatically become much harder to get

7. The Plaza Accord allowed significant cuts in overseas interest rates

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Source: OECD, US Treasury, HSBC

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agreement amongst a larger group of countries

each with its own agenda.

The problems of reaching a new international

agreement can be illustrated by the outcome of the

London G20 summit in April 2009. Even amidst the

financial crisis and the deep recession that followed,

it was not possible to reach agreement on the fiscal

stimulus wanted by the US and UK because

Germany and France were against it and the main

outcome was additional resources for the IMF to

lend money to countries in financial difficulty.

Conclusion

Consensus expectations are for a continued

gradual appreciation of the dollar in 2015 which,

if realised, would probably be beneficial to the

world economy in that it might allow Europe and

Japan to recover more quickly without doing

much damage to US growth. However, there is a

risk of a much more aggressive dollar rise which

would be damaging to world growth.

Unfortunately the likelihood of a new

international agreement to prevent this damaging

outcome is quite small as we are still a long way

from the extremes of exchange rates that might

provoke discussions of a new agreement and the

challenges of reaching an agreement are now

much greater given the divergence of policies and

the much wider group of countries involved in

negotiating such an agreement.

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USD dominance to persist

The USD is expected to be the best performing

currency in the world in 2015. Much of its strength

will be an echo of currency weakness elsewhere, but

the start of the US Fed’s tightening cycle will be

another key element of the USD’s allure. In fact, the

risk to our forecast of USD dominance is that the

currency could be even stronger than we envisage if

problems abroad were to intensify.

The USD story is largely one of relative monetary

policy, in particular the divergence between the

prospective tightening cycle in the US and the likely

additional easing from the Bank of Japan and the

European Central Bank. This parting of ways is

highly unusual as, more typically, the major central

banks tend to move in the same direction if not at

the same pace and magnitude. The Bank of

England, for example, may be destined to be some

distance later than the Fed in its next move, but it

will at least likely be a hike. For the BoJ and ECB,

the monetary tug of war has already exerted a

powerful influence over exchange rates, with both

the EUR and JPY weaker against the USD. With

the divergence in policy likely to continue, so too

will the currency adjustment.

History suggests that we may still be in the early

stages of the USD rally. The mega-rallies of the

early 1980s and late 1990s saw the USD

strengthen roughly 90% and 50%, respectively.

Even stripping out these two big moves, the

average USD rally has been 20%. So far, the USD

broad index has not even risen 10% since the start

of its upswing in mid-2014. History is no

constraint for now.

The more meaningful headwind to USD gains in

2015 will be any sign that US inflation is coming

in lower than expected. EUR and JPY weakness is

aimed at staving off the deflation threat. This

effectively means exporting deflation to the US. If

the US economic growth is strong enough to

generate sufficient inflation, then policymakers

will be relaxed about USD strength and the

downward pressure this puts on inflation.

However, if US growth falters or inflation dips,

then the tolerance for USD upside would fade,

and interest rate hikes could be delayed. US

inflation, not the US current account deficit, will

be the pinch point for this USD rally.

Overall, we expect the USD’s strong run during

H2 14 to extend throughout 2015. In fact, we

believe the risks to our USD forecast are skewed

towards even greater strength. If the Yen were to

slide alongside any erosion of policy credibility,

or the EUR were to wobble on fresh break-up

fears, the USD would capitalise. EM FX fallout

also holds scope to drive the USD higher.

G10

USD

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Draghi’d lower

We expect the EUR to weaken further during

2015, with EUR-USD forecast to finish the year at

1.15. The main driver to the decline will be the

contrast between the ECB’s additional monetary

easing and the start of the Fed’s tightening

campaign, however modest the latter proves.

However, the EUR will also face potential

downward pressure from political risk given the

rise of Euro-scepticism in many parts of the

Eurozone and wider EU.

The path of the EUR during the early part of 2015

will be determined by whether and when the ECB

enlarges its current monetary expansion. So far,

its efforts to boost the size of its balance sheet by

roughly a trillion euros have come up short. We

expect the central bank to embark on full-blown

QE during Q1 15. Although many expect such a

step from the ECB, the reality of this step being

taken would still be likely to provoke additional

EUR weakness. A sufficiently large-scale

programme would also foster additional EUR

selling, and while the ECB could be accused of

being rather slow to act, in general its

programmes have delivered in terms of size.

The downside path for EUR will also be driven by

ECB rhetoric as well as action. Although the ECB

has argued that it does not have an exchange rate

target, it has also made it clear that a weaker EUR

is helpful in pushing inflation higher towards

target. Given we expect inflation to average just

0.2% YoY during 2015, and dip beneath zero

during the year, the central bank will want

whatever help it can get via a weaker currency.

The rhetoric advocating a weaker EUR should

remain prevalent.

Politics could also play their part in pushing the

EUR lower. Although EUR break-up remains an

unlikely prospect, 2015 could be the year when

such fears are resurrected. The EUR remained

intact in the face of peripheral pressures in 2012

in large part because of the political backing for

the project. The ECB’s OMT programme has

provided the policy underpinning to the project,

but political support is the key element. The rise

of Euro-sceptic parties in recent years could raise

concerns that this wider commitment to the euro

project could be threatened by populism. Such

parties have significant positions in Greece,

France, Italy and Spain for example. Outside of

the Eurozone, the UK’s drift towards a possible

“in-out” referendum on EU membership may

further undermine the view that European

integration is a one-way process.

So the EUR will have to deal with an expanding

ECB balance sheet, anaemic growth, temporarily

negative inflation and heightened political

uncertainty. 2015 will be a testing year

EUR G10

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If at first you don’t succeed…

The story for the JPY in 2015 looks destined to

remain largely unchanged from 2014, namely

weakness engineered by aggressive monetary

easing. With the Fed likely moving in the opposite

direction, we expect USD-JPY to finish the year

at 128, a forecast which partly encompasses the

small but potentially costly tail risk that JPY

weakness gets out of control.

The Bank of Japan’s surprise acceleration of its

QE programme in October 2014 underlined the

central bank’s zealousness to achieve its inflation

target. Despite aggressive monetary easing we

believe the inflation target of 2% by March 2016

remains overly ambitious. The slide in commodity

prices adds to the downside risks to inflation, and

may limit the extent to which wages growth can

be invigorated. Further monetary stimulus is

therefore likely, possibly as early as April 2015.

It is also clear that whatever costs might be

associated with a weak JPY, notably for some

smaller enterprises, policymakers still believe

they are outweighed by the benefits. There is no

evidence that the tolerance for JPY weakness has

reached its limit within Japan policy, or will act as

a constraint on future easing.

Some may hope that structural reform might

provide additional impetus to the local stock

market, and thereby drive USD-JPY ever higher.

While the recent election result gave PM Abe a

fresh mandate, we do not expect any material

progress anytime soon as the legislative calendar

is already rather full. It is likely the pace of

structural reform will remain rather

underwhelming through the early part of 2015.

Once again, this will put the onus on monetary

policy to deliver the required stimulus.

The danger for the JPY is that current efforts to

engineer higher inflation largely through a weaker

exchange rate could spiral out of control. The

failure of earlier QE to deliver the desired level of

inflation did not prompt thoughts that this may be

the incorrect strategy. Rather, it merely

encouraged even more QE. If markets believe the

BoJ could simply throw ever more liquidity at a

failing inflation target, the risk that the currency

will be viewed as debased will grow. It is a risk

we believe should be at least partly factored into

base case forecast, especially as the implications

of a much weaker JPY on the region’s currency

war could be onerous.

The JPY’s decline in 2015 will not be a straight

line. Sporadic bouts of global unease may foster a

safe haven bid at times for the JPY, but in the end

the currency should succumb to the BoJ’s

monetary largesse and finish the year weaker. The

danger is that it weakens too much.

JPY G10

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Pounded lower

2014 proved a game of two halves for GBP, but

we expect 2015 to be rather more uniform with

relentless GBP weakness the likely theme. We

continue to see cyclical, political and structural

headwinds to GBP that we believe will see it

finish the year at 1.48 against the USD. Although

the factors behind its decline are somewhat

different from those affecting the EUR, we expect

both to suffer to a roughly similar extent. We

forecast EUR-GBP at 0.78 by year-end 2015.

UK interest rate hike expectations have already

retreated quite far into the future, with the first

hike not now expected by the market until early

2016. This retreat has been echoed in the

currency, and arguably much is already in the

price. Yet, GBP still has to face some headaches

on the cyclical front. What recovery we have seen

remains unbalanced, overly reliant on consumer

demand, with net exports and (more recently)

business investment now acting as a drag. We

expect the economy to slow further in H1 15.

With inflation expected to only average 1% in

2015, dipping below 1% in Q1 15, and requiring a

letter from the BoE’s governor to the Chancellor.

It is not an environment where cyclical forces will

be acting to support GBP.

If cyclical forces were GBP’s only headache, then

perhaps GBP could hope to outperform the EUR.

But GBP, like the EUR, also has to incorporate

rising political risk. There will be uncertainty

about the make-up of the government following

the May 2015 general election. The possibility of

another coalition remains in the UK’s more

fractured political party system. In addition, the

Euro-sceptic UKIP party has made strong gains in

recent elections. They will ensure the EU debate

remains prominent, and the possibility of a

Conservative Party sponsored EU “in-out”

referendum will stay firmly in the market’s mind

in the run-up to the election, and potentially for

some time thereafter depending on the election

outcome. It is a political risk premium that the

market needs to price in early having failed to do

so efficiently ahead of the Scottish independence

referendum in 2014.

The third vulnerability for the UK remains its

twin deficits. The unbalanced nature of the

recovery has exacerbated the current account

deficit which is expected to remain close to 5% of

GDP in 2015. Meanwhile, the UK fiscal deficit is

forecast at 3.3% of GDP despite more austerity. A

metric based on a simplistic combination of these

two short-falls would rank GBP amongst the

worst of the world’s currencies.

GBP has fallen a long way against the USD. We

believe it has further to fall, but it may be able to

match the beleaguered EUR and JPY in 2015.

GBP G10

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If it ain’t broke, don’t fix it

Our forecast profile for EUR-CHF of 1.20

throughout 2015 may not be the most dramatic of

profiles, but it remains the most plausible in our

view. To hold any other forecast would require

either a view that the CHF could weaken

independently against a EUR that is already

expected to be depreciating on the back of ECB

QE, or that the EUR-CHF floor is about to break.

We expect neither.

The case for retaining the EUR-CHF floor at 1.20

remains compelling. Admittedly, there are grounds

to anticipate an improvement in domestic demand,

with robust job creation and lower interest rates

driving consumption, in turn encouraging

investment growth. But overall GDP growth is

expected only to match the pace set in 2014, with

net trade offsetting that domestic demand upswing.

As a result, Swiss inflation which has averaged

close to zero throughout 2014, is not expected to

move far from this level in 2015.

With no shift in the inflation outlook, there is no

reason to anticipate any shift in the EUR-CHF

floor policy. The SNB can defend the floor

without limit so long as they are happy to

accumulate additional foreign exchange reserves.

The ‘gold referendum’ which sought to compel

the SNB to hold more reserves in gold reflected a

concern that the central bank was holding too

many assets in the EUR. Yet this referendum was

roundly defeated suggesting Switzerland’s voters

are not so unnerved that reserves are being parked

in fiat currencies like the EUR. So the political

objection to intervention is negligible, and with

inflation close to zero, so too is the economic

objection to unsterilized intervention. The SNB’s

promise to intervene in an unlimited way remains

as potent as ever.

The floor is now also being defended via negative

interest rates, and the SNB has pointed to other

options still being open if required. They may

need to be used if the ECB’s QE programme

prompts widespread EUR selling, but maintaining

the floor will remain the imperative.

Given our forecast that the floor will remain

intact, the low range for any profile therefore

becomes 1.20 for 2015. The remaining question is

whether EUR-CHF could push higher through the

year. This feels unlikely given our expectation for

a QE programme from the ECB, potential

heightened break-up fears in the Eurozone,

Switzerland’s continued current account surplus

and Switzerland’s lower inflation rate than the

Eurozone. It is not a combination which points to

higher EUR-CHF. As a result, we retain our view

that EUR-CHF will flat-line at 1.20.

CHF G10

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Weakness only temporary

The weakness of the NOK in the latter part of

2014 was far more pronounced than we were

expecting, as the central bank responded to the

drop in oil prices by delivering a surprise cut in

the policy interest rate. They also left the door

open to a further easing. This was somewhat

surprising given the robust GDP growth and

falling unemployment rate. It seems the

policymakers believe the spill-over effect from

the drag in the oil sector will be sizeable enough

to justify some support for the non-oil sector.

The combination of lower oil prices and the

dovish Norges Bank will make it hard for the

NOK to rally substantially anytime soon.

However, we expect this to be the end of the rate

cut cycle in Norway as we believe the mainland

economy will fare better than some expect, and

core inflation will remain robust. Rising wages

and house prices also argue against further easing.

As a result, we expect EUR-NOK to fall during

2015, but the move back to a more reasonable

level will first require the rout in oil prices to stop.

We see NOK appreciating gradually against the

EUR through 2015 as the robustness of the

Norwegian economy comes to the fore compared

to the Eurozone.

The SEK has also remained on the defensive as

the economy battles weakness in growth and an

inflation rate which remains uncomfortably low.

The one reprieve for policymakers is that the SEK

has continued to depreciate against the EUR,

helping to fend off at least one source of deflation.

However, the danger is that EUR-SEK begins to

push lower if the ECB embarks on full-blown QE

early in 2015 as we are expecting.

The policy options for the Riksbank to respond to

unwanted SEK strength are limited. The path of

rate hikes could be pushed out further into the

future, but it is unclear that this would have a

potent impact on the currency. Credit easing could

be constrained by the high level of household

debt, QE by the relatively small government bond

market. We are forecasting a rate cut in the April

meeting to -0.25% as the Riksbank tries to fend

off deflation.

We continue to believe policymakers will be keen

to prevent EUR-SEK falling far in response to

ECB QE, and a floor on EUR-SEK remains a

possibility.

NOK & SEKG10

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Still on the ropes

The CAD remained on the defensive for the latter

part of 2014, pressured by continued USD

strength and the sharp decline in oil prices. The

latest Bank of Canada statement was modestly

more upbeat on Canadian growth, but cautious on

the global growth outlook and the effects of lower

oil prices. We expect the firmer bias in USD-CAD

to persist.

The dramatic decline in oil prices has, not

surprisingly, been associated with weaker levels

of CAD. But despite the Canadian economy’s

sensitivity to oil—energy and energy-related

products account for roughly a quarter of

Canada’s exports—the fallout on the CAD itself

has been somewhat contained relative to that of

other currencies. We noted in last month’s update

that the CAD had outperformed most other G10

currencies versus the USD since the decline in oil

prices began last July, and that continues to be the

case into the end of 2014.

But there are some other factors to consider in

terms of the impact of lower oil prices on the

CAD. Canada imports refined oil products, and it

benefits from a reduction in those prices. In

addition, the discount of Canadian-produced

Western Canada Select oil to US-produced West

Texas Intermediate oil is relatively small by

historic standards. That suggests that Canadian oil

continues to be exported to the US, contrary to the

reduced US demand for crude oil imports from

other countries. Along those same lines, Canada’s

concentration of exports to the US leaves it less

exposed to diminished demand in some other key

commodity consuming economies (i.e. China).

And in the medium term, to the extent that lower

oil prices support increased US demand and

overall growth, it will have positive spill over

effects on Canada. However, that will likely only

mitigate some of the negative impact of lower oil

prices on the CAD.

Importantly, the BoC does not appear to be in any

hurry to start to normalize policy, and financial

markets have also remained largely of the same

opinion. 2-year Canada overnight index swaps, an

indication of where the market expects the

overnight interest rate to be in two years’ time, are

trading at 1.13%, near the middle of the

approximate 1.0%-1.25% range they have held for

most of this year, and implying only a very

limited prospect for BoC rate increases over that

two-year horizon. In other words, the CAD is not

getting any obvious support from BoC policy

speculation, and we expect that condition to

persist for the foreseeable future.

The anticipated outperformance of the USD, and

perhaps more immediately some further effects of

lower commodity prices, keep us bullish on USD-

CAD in both the near and medium terms.

CAD G10

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Caught in the USD bull run

Both the AUD and the NZD fell victim to the USD

bull run in 2014, which gathered pace in Q4.

Looking into 2015, we see a similar story; both the

AUD and NZD will continue to fall, finishing the

year at 0.78 and 0.73 respectively against the USD.

There are however differing reasons for the

respective falls. We expect New Zealand to see

strong growth in 2015 and so the weakness is a

USD-strength story. By contrast, Australia has

seen slowing growth as rebalancing occurs, albeit

at a restrained pace. We expect this to continue

through 2015.

For the AUD, two of the ‘3Cs’ (China,

Commodities and Carry) will continue to be

fundamental through 2015. Our economists have

recently revised down their growth forecasts in

China and we are now forecasting 7.3% growth

YoY in 2015. They also see further monetary

policy easing in China to try and stimulate growth.

The second C, commodities, was crucial in the final

quarter of 2014 and will continue to be so during

2015. Commodity prices have fallen across the

board. Whilst in recent months much of the attention

has been on the large decline in oil prices, key

commodities for Australia, such as iron ore, have

seen a similarly large decline, with iron ore falling

30% since the start of July 2014. This problem may

persist through 2015 due to Australia’s large reliance

on exports of raw materials.

On carry, there is some divergence with rate hike

expectations in 2015. Rate hike expectations in

Australia have been consistently pushed back

through 2014 and it has now comes to the stage

that it is not hikes but instead cuts that are being

anticipated by the market. We disagree, expecting

a hike during Q4 15, a factor which should ease

some of the selling pressure on the AUD.

In contrast, the market sees no movement from

the RBNZ until H2 2015 when the direction is

likely to be up – a view we agree with. Other

factors may be more pertinent to NZD fortunes.

In New Zealand, the main commodity of interest

is dairy. A clear risk is the continued softness in

dairy prices which has put pressure on farming

incomes in the 2014-15 season. Whilst one bad

season should not put the sector under severe

strain, continued low dairy prices could weigh on

the currency. Construction projects will continue

to boost the New Zealand economy as the

rebuilding of Canterbury continues through 2015.

AUD & NZDG10

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Prepare for higher volatility

2014 ended as the first year of RMB spot

depreciation against the USD since 2005’s de-peg,

even though there has been an acceleration of

RMB internationalisation.

In 2014, China announced a broader agenda of

economic reforms and rebalancing. This has

important implications for FX policy and the

RMB in 2015, most notably that:

The PBoC will steer further away from

accumulating sizable FX reserves

It will internationalise the RMB and promote

the RMB as a reserve currency

China will try to remain on the side-lines of

global currency tensions seen elsewhere

There are some key events on the calendar this

year that could affect the RMB’s performance and

internationalisation. For example, the expected

review of the IMF’s Special Drawing Rights

could see the RMB included in this currency

basket. Also, China A-shares may be included in

the MSCI EM index.

We believe the RMB will continue to outperform

other Asian currencies in 2015, although the room

for this is narrowing in line with China’s

economic rebalancing. We are looking for modest

RMB depreciation against the USD in 2015.

More importantly, USD-RMB volatility will

likely rise in both the spot and FX forwards

markets. This will be a function of further reforms

to make the RMB more market driven. But higher

volatility will also emerge due to monetary policy

divergence between the US and other major

central banks, including the PBoC.In fact, there is

a significant risk of USD-RMB overshooting our

year-end forecast of 6.22 in Q1: Fed tightening

concerns and/or further easing measures by the

BoJ and the ECB could coincide with rate cuts by

the PBoC, as well as higher USD-CNY fixings

and capital outflows ("hot money", services trade

deficits, outward direct investments) on the back

of seasonally thinner trade surpluses.

Indeed, the current demand-supply picture still

suggests a long USD bias in the onshore market –

the USD170bn of estimated "hot money" outflows

(importer hedging flows) between May and

November is only half of the USD310bn of

inflows seen during the September 2013 - April

2014 period. We may see more outflows before

corporates fully cover their FX exposures.

There is a risk that spot USD-CNY could touch

the upper bound of the daily trading band. In that

event, the PBoC would have to resume spot USD

selling, raise the USD-CNY fix significantly

higher and/or widen the band. Band widening

would be consistent with China's commitment to

FX reforms.

Given USD-CNH and onshore USD-CNY

forward curves are steep and have priced in

modest spot RMB depreciation, we prefer to look

for opportunities to position for higher spot

volatility via FX forward curve flatteners.

RMB Asia

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In a tough spot

In the latter part of 2014, the KRW was weighed

down by large outflows reflecting, initially,

increased FX intervention, and subsequently,

portfolio outflows by both locals and foreigners, a

surge in RMB deposits (of which only a fifth was

converted from USD deposits), as well as a record

amount of USD-KRW NDF purchases by

foreigners from banks in Korea.

The outflows stem from competitive concerns due

to a weak JPY and persistent BoK rate cut

expectations, as a result of additional BoJ

monetary easing (see Asian FX Focus: KRW:

What goes up must come down, 3 October 2014).

The positive correlation between USD-KRW and

USD-JPY is at its highest since the start of

Abenomics as: (i) the KRW, by some measures,

can no longer be regarded as under-valued;

(ii) Korean assets have become lower yielding;

(iii) Japanese exporters have started to lower their

contract prices; and (iv) the urgency for Korea

policymakers to boost exports has risen amid

sluggish domestic demand.

We expect the outflows to persist and USD-KRW

to stay elevated in 2015, especially if both the BoJ

and the BoK ease further. Portfolio liabilities

accumulated over the last five years are large, at

35% of FX reserves, and could be FX hedged

more than in the past. Newly acquired portfolio

assets are also less likely to be currency hedged,

given the sharp drop in FX swap rates.

While there are expectations a stronger dividend

policy by the government could encourage foreign

equity inflows, this is balanced by a risk of

portfolio rebalancing outflows in the event that

China A-shares are included in the MSCI index,

and outflows on the back of downward revisions

in earnings growth.

Exporters could further increase their FX deposits,

in anticipation of a stronger USD and higher

yields. Moreover, the authorities are aggressively

developing the offshore RMB market in Seoul,

aiming for direct RMB-KRW trading and greater

utilisation of the RQFII quota. Offshore RMB

deposits could continue growing in Korea.

Nevertheless, we believe the BoK will tread

cautiously in a ‘currency war’, given the high

level of household debt (which could constrain the

rate cut cycle) and since Korea remains a net

debtor from an international investment position

perspective (despite the decline in short-term

external debt). A sharp rise in USD-KRW could

cause excessive market volatility and uncertainty

that would actually weigh on growth.

The KRW will also be supported by a large

current account surplus (USD82bn in Jan-Nov

2014). In our view, the downside risk to this from

a weak JPY is more than offset by the upside risk

from the sharp decline in oil prices (note: oil

comprises 25% of Korea’s imports). The BoK is

currently assuming an oil price of USD99/bbl and

a current account surplus of USD40bn in 2015 but

this would most certainly change in its January

economic outlook.

KRW Asia

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=5eeMe8m5xp&n=432578.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=5eeMe8m5xp&n=432578.PDF

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Fast forward in 2015

The INR has help up relatively well versus other

Asia currencies in recent months, supported by

strong portfolio inflows and reform optimism,

while improving macro data also helped. This

story should continue in 2015, in our view.

Although foreign equity inflows moderated

slightly in early Q4 2014, and foreign institutional

investors have nearly exhausted their USD25bn

limit in government bonds, the improvement in

the current account deficit and the real interest

rate profile will likely sustain the INR’s steady

performance in 2015. This is partly due to a

timely decline in global commodity prices (note:

India is a large net crude importer; see

Economics: India and oil: Relief on all fronts,

20 October 2014), but also a result of reforms and

a more credible mix of monetary and FX policies.

Indeed, we believe the INR’s long-term outlook

has improved (see Asian FX Focus: INR: Fast

forward to 2015, 29 October 2014). We are

particularly encouraged by recent measures aimed

at attracting investment and controlling the twin

current account and fiscal deficits.

That said, the crucial winter session of Parliament,

which concluded on 23 December, added little

cheer to markets. Out of 37 proposed bills, only

12 were passed by both houses of Parliament. In

addition, key bills involving coal mines and FDI

in insurance were not passed in the upper house,

where the BJP is in minority. The government

pushed these via the ordinance route, by which

they will be deemed laws for now, but need to be

ratified in the upcoming budget session of

Parliament in February.

Meanwhile, on a brighter note, the important

Goods and Services Tax (GST) bill was tabled in

this session, likely paving way for its

implementation in April 2016. We await more

concrete reforms in the coming months, including

changes to land acquisition, more government

divestment plans, and an increase in FII limits.

We also expect the RBI’s monetary and FX policy

to manage INR volatility. The RBI’s commitment

to achieving its 6% inflation target by January

2016 will likely keep real rates in the positive

territory, even if it does cut policy rates in 2015.

On FX policy, we note that the RBI’s ability to

curb excessive INR weakness is now at its

strongest since 2008.The RBI has accumulated

large amounts of spot FX reserves and has

neutralised its previous net short FX forward

position. However, the RBI will also be wary of

significant INR appreciation on a REER basis,

given that its own such measure is showing signs

of over-valuation. The central bank has been

buying USD at higher spot levels in recent months.

In sum, we believe the INR will be one of the

more resilient currencies in EM Asia in 2015,

provided the domestic policy framework does not

disappoint. Apart from stronger fundamentals, we

also believe the external backdrop – low core

bond yields – will be favourable to high-yielding

currencies. But we see more room to position for

a further moderation in FX forward points than

through the spot rate, given the RBI’s likely

curbing of appreciation.

INR Asia

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=nauR0acM6q&n=434211.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=kHyKbgl9Y7&n=435514.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=kHyKbgl9Y7&n=435514.PDF

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IDR – a reformed character?

The modest weakness of the IDR in the latest

round of USD strength is in contrast to what

happened during the ‘taper tantrum’ in mid-2013.

This change is partly a function of a more credible

mix of monetary, FX and macro-prudential

policies in Indonesia starting from late last year

(see Asian FX Focus: IDR: Better but not enough,

9 October 2014).

Bank Indonesia (BI) has maintained prudent

monetary policy, which forms a sizable real yield

buffer against the fuel price hike implemented in

November 2014 and the backdrop of a more

hawkish Fed. Indeed, BI pre-emptively raised the

policy rate by 25bp the very same evening the fuel

subsidy cut was announced.

Meanwhile, the central bank also adopted a more

flexible FX policy (i.e. allowing the IDR to adjust

to market forces), and encouraged state-owned

enterprises to conduct FX hedging. The OJK

(Financial Services Authority) have also

implemented measures to address tight banking

system liquidity, which, over time, will increase

BI’s flexibility in handling potential capital

outflow risks.

This combination of prudent monetary policy,

flexible FX policy and macro-prudential policies

has contributed to an important delinking of credit

growth and movements of the IDR, which signals

a likelihood of a soft landing for the credit cycle.

The previous tight relationship between the two

had contributed to simultaneous banking and

balance of payment shocks in the past.

Another key factor that has been supporting the

IDR is reform optimism surrounding the newly

elected president. Despite not having a majority in

parliament at the moment and having to make

some compromises in his cabinet line-up,

President Jokowi is popular and expected to

unleash some key structural reforms.

This reform agenda was kicked off by the cut of

fuel subsidies in November 2014, followed by the

scrapping of gasoline subsidies and a fixed diesel

subsidy, effective from 1 January 2015. The

government will likely use the funds saved on

subsidy spending to help launch an ambitious

infrastructure plan that ranges from building

urban road and rail systems, making Indonesia a

maritime hub, as well as developing the

manufacturing sector.

Such plans, if properly implemented, could help the

economy rebalance away from commodities

towards higher value-added exports, and keep FDI

inflows relatively strong. This is necessary to

counter the broader BoP challenges, including a

less than robust terms of trade and wide income

and service deficits. We still look for the IDR to

weaken slightly versus the USD as part of a BoP

adjustment; however, reforms should help limit the

amount of required currency weakness compared to

historical adjustments seen by the IDR.

IDR Asia

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Limited upside potential

We retain a moderately constructive view on the

PLN in 2015. Our forecast is based on the

assumption that the key policy rate in Poland is

likely to remain stable, whilst the ECB will

continue its monetary easing. However, we think

that the upside is limited as the currency does not

display any particular sign of misalignment

relative to important macro variables. We see

EUR-PLN ending the year at 4.05.

The Polish central bank is reluctant to reduce its

policy rate below 2%. Part of the lacklustre

performance of the zloty against the EUR and its

regional peers in 2014 has been due to

expectations of substantive cuts from the NBP in

the face of excessively low inflation. However,

the central bank’s reaction function has changed.

Monetary policy is now more determined by GDP

growth than inflation. The central bank’s policy

bias for easing may remain given the

undershooting of the inflation target, but it would

take another shift down in GDP growth for the

MPC to cut rates to new lows. We expect GDP

growth to remain around 3%, leading the NBP to

keep its policy rate unchanged. This stance is

likely to support the PLN.

A policy rate floored at 2% should also be put in

the European context with the ECB easing

underway. We expect ECB to deliver more via

full-blown QE in Q1. This is likely to create a

boost to a PLN offering 2% yield and a

historically high real interest rate. Even with the

return of Polish inflation into positive territory in

the coming months, the real policy rate will stay

high in absolute terms and also from a historical

perspective. This is an important element

increasing the PLN attractiveness vs both the

EUR and relative to its regional peers.

Nevertheless, we do not think that the PLN has a

large upside potential. Contrary to some Polish

MPC members, we do not see any clear evidence

of PLN undervaluation. Some metrics send

conflicting signals but our overall assessment is

that the PLN is rather fairly valued. Moreover, in

the past two years, the PLN nominal effective

exchange rate has been very stable. This stability

was unexpected given the relative strength of the

Polish economy, the historical reduction of the

current account deficit and the improvement in the

terms of trade. Admittedly, when capital inflows

were large during 2011-2012 period, the current

account deficit was still sizeable. One factor offset

the other, so the impact on the PLN was mild.

Similarly, the rapid narrowing of the current

account deficit since mid-2012 has coincided with

a reduction in capital inflows with the same tepid

consequence on the currency. Looking ahead, it is

difficult to envisage the PLN recording significant

gains with none of these factors expected to vary

significantly in coming quarters.

The main risk to this mild PLN bullish view is a

change in NBP’s stance and further rate cuts.

Economic growth unexpectedly decelerating

towards 2% would be a strong case for a cut. It is

also worth emphasising that a PLN appreciation

may lead to rate cuts as some MPC members sees

this risk as a reason to ease further.

PLN CEEMEA

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Caught between improving macro-mix and strong USD Turkey’s macro mix will improve in 2015. Inflation

will decelerate significantly in coming months

towards 6% after having hovered above 9% during

most of 2014. This improvement of the inflation

panorama is not only due to lower energy prices but

also to an underlying improvement of the inflation

momentum due to the effects of the past tightening

of the monetary policy.

Oil prices will have a significant impact on

Turkey’s main macro vulnerability, namely its

current account deficit. There is no doubt that the

deficit will narrow in 2015 to a level unseen in the

past 10 years if we exclude 2009 when the

economy contracted by almost 5%. The

substantive reduction of Turkey’s energy bill is

likely to bring the current account deficit to 5% of

GDP. This forecast is very conservative given the

big drop oil price recorded in recent weeks. If

sustained, the deficit could be 1-2pp lower. A

USD10 fall in oil price has indeed an impact of

USD3.2bn on the current account.

This combination of falling inflation and narrowing

current account deficit is TRY-supportive. The TRY

should also benefit from a mechanical improvement

of the country’s terms of trade, whilst the real

effective exchange rate will be less under upside

pressure thanks to lower inflation, leaving more

room for a nominal TRY appreciation.

Overall, Turkey’s macro variables point to an

appreciation of the TRY in 2015. However, there

are two important variables to add to the macro

equation. First, the Turkish central bank’s

temptation to cut its interest rates in a context of

falling inflation. Keeping policy rates unchanged

anchors inflation expectations and solidifies the

credibility of the inflation targeting policy. This is

clearly the best option. However, we cannot rule

out a moderate loosening of the monetary policy

that could have a negative impact on the TRY.

Second, USD strength could be another obstacle

to a TRY’s appreciation. Rising US interest rates

would certainly be detrimental to the lira even

though Turkey’s macro & financial fundamentals

have improved compared to 2013 when the

Fed announced the end of the super loose

monetary policy.

Overall, we believe that USD-TRY is likely to

remain under upside pressure in 2015 mainly as a

consequence of a strong USD. However, we do

not expect a large depreciation of the TRY

because of an improving domestic macro-mix.

This improvement may transpire via an

outperformance against its regional peers or vs the

EUR. There is indeed a possibility to see a de-

correlation between USD-TRY and EUR-TRY if

as we expect the ECB delivers a full-blown QE

driving the EUR lower. In other words, EUR-

TRY trend lower in 2015 even if USD-TRY ends

the year at 2.40. In the relative-value space, the

better macro Turkish panorama could be also

express via a long TRY-ZAR position.

TRY CEEMEA

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USD hostage

The sharp fall in the oil price brings positives to

South Africa’s macro picture. Similarly to

Turkey, the lower energy bill will ease

inflationary pressures and improve the current

account balance. However, there are uncertainties

to what extent the ZAR can benefit from better

macro fundamentals. A continual rise of the USD

in 2015 on the back of Fed policy normalisation is

likely to push USD-ZAR to new multiple year-

highs. A reduction of some macro vulnerabilities

would only limit the ZAR’s depreciation.

It is also worth emphasising that uncertainties

remain on the scale of the macro improvement

expected for 2015. South Africa continues to face

numerous structural issues and risks. The energy

constraints (shortages and rationing of electricity)

could undermine part of the positive implications

of lower oil price and consequently GDP growth

prospects. Although the situation has improved in

the labour market since the end of summer 2014,

strikes and instability remain important risks in

2015. Wage negotiations in the public and gold

sector may create new disruption in production.

On the current account balance side, which is the

key variable for the currency, a certain degree of

cautiousness prevails. Despite a substantial FX

depreciation, a rebalancing has not materialised.

The trade deficit has continued to widen to record

levels and the current account was about 6% of

GDP in 2014. A reduction is likely to take place

in 2015 thanks to a recovery in some export

sectors impacted by strikes last year, but a lot will

depend on imports. Subdued domestic demand

and falling oil prices should curtail import growth.

Would it be enough to significantly reduce the

trade deficit, particularly when the price of other

commodities that South Africa exports are also

weak? The jury is out.

The only genuinely ZAR-positive country-

specific element is the central bank’s adequate

policy. The SARB does not target the exchange

rate but adjusts its policy to its potential

consequences when it varies. Lower energy prices

offer some space for the SARB to keep a neutral

bias in the first months of the year but we believe

that a cumulative 75bp rate hike to 6.50% will be

delivered later in the year. The SARB will

respond to sticky core inflation but also to the Fed

tightening. This appropriate policy should limit

the downside pressures on the ZAR.

Overall, we expect a mild ZAR depreciation in

2015 with USD-ZAR reaching 12 by year-end.

However, the cross could record wide fluctuations

during the course this year.

ZAR CEEMEA

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Recommended strategy

Current USD-MXN strength may be a

temporary over-shoot; look to play MXN

bounce vs EUR and JPY.

Medium-term, we are more neutral on MXN

but remain significantly more bearish than

consensus, looking for USD-MXN at 14.80

year-end vs 13.50 consensus.

Key drivers

Oil

Lower oil prices threaten Mexico’s fiscal accounts

and represent a drag on growth. Sentiment on

Mexico had already been slipping on security

concerns and delays to infrastructure investment

projects and the oil drop is taking Mexico into the

‘vulnerable EM’ camp, in our view. From a trade

balance perspective, Mexico is not a major oil

exporter, but its reliance on oil for roughly 30% of

fiscal revenues still places the country in the

cross-hairs as oil prices decline.

Domestic growth

Growth is finally showing signs of picking up,

mainly thanks to public sector spending finally

kicking in. This will be an important driver of

sentiment in 2015 and, assuming growth can keep

accelerating, could enable the MXN to resist some

of the USD’s strength in 2015.

FX policy

Mexico’s Foreign Exchange Commission (FEC)

re-introduced their FX volatility-reducing

mechanism on 9th December, involving selling

USD200m should the MXN weaken by 1.5%

from the prior day’s fixing rate. The decision

signals that the authorities are not entirely

comfortable with the pace of the MXN’s recent

sell-off, but are not necessarily looking to stop or

reverse the MXN’s decline. We expect the policy

to help stabilise the MXN, as it did in 2012 when

last employed. See ‘MXN: Authorities re-

introduce volatility control USD sales’, 8 Dec.

Key risks

Security, corruption and social protests

Security issues have been simmering on the back

burner for many years now, but recent events have

raised more concerns. President Pena Nieto has

announced a series of measures aimed at

improving security, including unifying the multi-

layered police forces and boosting growth in

economically troubled areas.

Lower oil prices and FDI to oil sector

Also, foreign oil companies are gearing up to

channel significant investment flows into

Mexico's oil industry. The first round of bidding,

involving 171 blocks with 110 exploration blocks

and 60 production blocks will commence in 1H

2015, with initial contracts awarded by 21 August,

2015. The drop in oil has raised some concerns

regarding the likely competitiveness of bids.

Portfolio outflows

Portfolio inflows have been the dominant factor

within Mexico’s balance of payments in recent

years. These have slowed in recent months, but

have not yet seen any significant reversals. This is

one of the key risks for the currency in 2015.

MXN LatAm

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=pTqiNcti9N&n=440887.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=pTqiNcti9N&n=440887.PDF

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Recommended strategy

We are bearish on the BRL, but prefer to buy

on dips due to high carry

We see USD-BRL moving up to 3.00 by

year-end, vs consensus forecasts of 2.71

Key drivers

Fiscal/debt/growth dynamics

The main focus of the government in 2015 is to

ensure that public debt as a percent of GDP

remains on a downward trajectory in order to

reduce the risk of a credit downgrade. A

successful fiscal adjustment will improve Brazil’s

medium-term outlook but the adjustments will be

an additional drag on the economy. Growth

slowed down much faster than anticipated in

2014, and HSBC is now forecasting a contraction

of -0.5% in 2015 (see: ‘Brazil Multi-asset views:

Lowering growth and BRL forecasts’,

1 December, 2014).

FX intervention policy

We expect the BCB to continue intervening

(currently at the reduced rate of selling USD2bn

per month), but further adjustments are possible.

In our view, the main objective of the intervention

is to dampen volatility and to satisfy FX demand

in the system. FX stability will be important for

the implementation of the adjustment agenda.

Balance of payments

We see another year of balance of payments

deterioration due to a) a persistent current account

deficit, and b) worsening in the quality of capital

flows financing the deficit. The current account

deficit has hovered around USD80bn (or 3.6% of

GDP) in 2013-2014, in spite of the 25%

depreciation of the BRL REER from the highs.

Since 2010, FDI has plateaued around USD65-

70bn, and HSBC looks for it to fall to USD45bn

this year. Moreover, the quality of FDI has

declined as the proportion of debt or

intercompany loans, which is more cyclical, has

risen relative to new equity investments.

This leaves a gap of around USD35bn for this

year in FX funding and is another reason that we

expect the BCB to remain engaged supplying

USDs in the market in 2015.

Key risks

Policy mistakes or inconsistencies could further

unsettle investors. Lower global growth and

commodity prices could impair the effectiveness

of the adjustments, testing political resolve to stay

the course.

The ongoing corruption investigations into

Petrobras also increases uncertainty for

investment and business activity in sectors

affected (i.e. in construction and infrastructure).

And once again electricity rationing will be a risk

to our economic outlook in 2015.

There are also positive risks. In particular, we think

any period of calm in global markets could see BRL

benefiting from renewed interest for carry, given the

general deflationary mood in the global economy.

This would not necessarily solve the BRL’s

structural issues, but it could delay the adjustment.

BRL LatAm

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=VdKTdL6kt7&n=439954.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=VdKTdL6kt7&n=439954.PDF

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Gold to make modest gains

We are raising our average gold price forecast for

2015 to USD1,234/oz and introduce a 2017

forecast. We leave our 2016 and long term prices

unchanged, as shown in the table below. We

estimate a trading range of USD1,120/oz to

USD1,305/oz for 2015.

After falling sharply in 2013, the year that also

marked the end of a more than decade old bull

market gold moved largely sideways in 2014.

Starting 2014 at USD1,205/oz and ending the year

at USD1,188/oz. A strong USD, disinflation,

lower demand for safe havens and US monetary

policy shifts created the climate for further

investor liquidation. Holdings in in the gold-

exchange traded funds (ETFs) dropped but net

long positions on the Comex were rebuilt from

historically low levels which helped support

prices towards year end – see chart 1.

Gold as a currency

As a surrogate or alternative currency, gold is

sensitive to movements in the foreign exchange

markets. Gold has a traditional inverse correlation

to the USD, in large part because the USD is

widely regarded as the world’s principal reserve

currency and gold as the world’s principal hard

asset, it is logical that the two would be inversely

correlated. The case for the inverse relationship

rests largely on gold’s being traded primarily in

US dollars. USD strength played an important, if

not key role in gold’s inability to rally in 2014.

This relationship has broken down periodically,

sometimes for extended periods, most notably

during the last economic crisis, although in the

long run, the relationship has always been re-

established. We think this may happen again in

2015. The possibility that the forex market is

under-estimating the risk of destabilizing currency

moves is an important element in our view that

gold prices may gain modestly in 2015, even in

the face of a stronger USD. Should extreme USD

Precious Metals

We raise our 2015 gold forecast based on the possibility that

further USD strength could trigger safe haven demand for bullion;

We lower our PGM forecasts; silver should gain on good industrial

demand and lower mine output

We introduce a 2017 forecast for gold and the PGMs

HSBC gold price forecast (USD/oz)

_________ 2015f ___________ ___________ 2016f ____________ __________ 2017f ___________ _______ Long term ________ Old New Old New Old New Old New

1,175 1,234 1,275 unch 1,300 1,325 Unch

Source: HSBC

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strength lead to dislocation in the currency

markets in combination with enhanced

geopolitical risk, gold demand could increase as

investors seek safe havens. Gains however, may

be constrained by the negative impact of

disinflation. There is also the possibility that

further USD gains will not prove to be disorderly

and therefore not gold bullish. Less

accommodative US monetary policy should also

act to limit gains.

Supply and demand

That said, gold prices will not be entirely

determined by USD direction and Fed policy. We

expect tight supply and improving physical

demand to buoy gold later in 2015. The bulk of

physical demand is located in the emerging world

and EM demand will be key in influencing prices,

helping to set both the floor and ceiling of the

market. We expect any significant price drop to

near cUSD1,120/oz to spur jewellery and coin and

bar purchases in lower income nations. There is

also the possibility that high tariffs aimed at

curbing India’s gold imports will be relaxed this

year. Conversely, rallies near USD1,300/oz are

likely to reduce EM demand and act to cap prices.

Based on low prices and likely income growth we

believe EM demand in general and Chinese

demand in particular will be fairly price positive.

Low prices will help keep supply tight in part by

discouraging scrap supplies from the recycling

markets, as holders have reduced incentive to

hand in gold for reprocessing. Although average

costs of production are generally well below

current levels, prices below USD1,200/oz have

also discouraged long term increases in output

from higher cost producers. Should prices drop

closer to USD1,100/oz producers may be further

compelled to close and/or restructure high cost

mines. We expect the combination of tight

supplies and good physical demand to help

promote a price recovery later this year.

Silver, a rising star

We are keeping our forecasts unchanged, as

shown in the table. For 2015 we expect an

average price of USD17.65/oz with a

USD15.25-21.25 range.

HSBC silver price forecast (USD/oz)

_________ 2015f ___________ ___________ 2016f ____________ __________ 2017f ___________ ________Long term _________ Old New Old New Old New Old New

17.65 Unch 20.50 unch 21.00 Unch 24.00 unch

Source: HSBC

1. USD to be the outperformer in 2015

0

20

40

60

80

100

120

140

300

500

700

900

1,100

1,300

1,500

1,700

1,900

2,100

2,300

Aug-06 Apr-07 Dec-07 Aug-08 Apr-09 Dec-09 Aug-10 Apr-11 Dec-11 Aug-12 Apr-13 Dec-13 Aug-14

Gold in ETFs (RHS) Spec position in COMEX (RHS) Gold Price USD/oz (LHS)Moz


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Our positive price outlook is based on a likely

easing in mine production after a decade of

increases. Also, low prices are constricting scrap

supplies. Industrial demand, which comprises half

of total silver consumption, is expected to be

buoyant based on HSBC macroeconomic

industrial production forecasts. Holdings in silver

ETFs have been steady. This plus recovering

jewellery and coin sales should buoy prices.

PGMs deficits are supportive

We are lowering our platinum 2015 and 2016

price forecasts and leaving our long term forecast

unchanged. We forecast average prices for

platinum for 2015 at USD1,337/oz. We lower our

palladium price forecast for 2015 to USD837/oz

and leave our 2016, and long term prices

unchanged. We expect a wide trading range this

year for platinum of USD1,180/oz to

USD1,430/oz and for palladium of USD755/oz to

USD925/oz.

We attribute much of platinum’s poor price

performance in 2014 to the negative influence of

low gold prices. If platinum can decouple from

gold this year, we would expect a more robust

price performance. We anticipate ongoing

structural production/consumption deficits in both

PGM markets this year will support prices. Gains

may be capped however as in the case of platinum

above ground stocks may be adequate to service

near term deficits. Also low lease rates imply

there is no shortage of available metal for either

metal. Platinum and to a lesser degree palladium

mine output is expected to recover further from

the impact of last year’s South African mining

strike. This should ease but not eliminate the

deficits. Growing auto and mixed industrial

demand in 2015 is also support the PGMs.

Palladium is likely to benefit from the end of

Russian stockpile exports.

HSBC PGMs price forecasts (USD/oz)

________ 2015f _________ ________ 2016f _________ ________ 2017f _________ _____ Long term _______ Old New Old New Old New Old New

Platinum 1,505 1,337 1,600 1,510 1,600 1,675 unch Palladium 855 837 880 Unch 890 900 unch

Source: HSBC

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For full details of the construction methodology of

the HSBC REERs, please see “HSBC’s New

Volume-Weighted REERs” Currency Outlook

April 2009.

The value of a currency

Since FX prices are always given as the amount of

one currency that can be bought with another, the

inherent value of a currency is not defined. For

example, if EUR-USD goes up, this could be

because the EUR has increased in value, the USD

has decreased in value, or a combination of both.

One possible method for getting some insight into

changes in the value of a currency is to look at

movements in the value of a basket of other

currencies against the currency of interest. For

example, if EUR-USD increased over some time

period, one could see how EUR had performed

against a range of other currencies to determine

whether EUR has become generally more valuable

or whether this was simply a USD-based move. An

effective exchange rate is an attempt to do this and to

represent the moves in index form.

There are two main approaches to building an

effective exchange rate: Nominal Effective

Exchange Rates (NEERs) and Real Effective

Exchange Rates (REERs). NEERs simply track

the weighted average returns of a basket of other

currencies against the currency being investigated;

REERs deflate the returns in an attempt to

compensate for the differing rates of inflation in

different countries. The reason for doing this is

that, particularly over long time frames, inflation

can have a large impact on the purchasing power

of a currency.

How should we weight the basket?

If we are trying to create an index for the change

in value of a currency against a basket of other

currencies, we now need to decide on how to

weight our basket. One possible solution would be

to simply have an equally-weighted basket. The

rationale for this would be that there is no a priori

reason for choosing to put more emphasis on any

one exchange rate. However, this could clearly

lead to the situation where a large move in a

relatively small currency can strongly influence

the REERs and NEERs for all other currencies.

To avoid this, the indices are generally weighted

so that more “important” currencies get higher

weighting. This, of course, begs the question of

how “importance” is defined.

Trade Weights

Weighting the basket by bilateral trade-weights is

the most common weighting procedure for

creating an effective exchange rate index. This is

because the indices are often used to measure the

likely impact of exchange rate moves on a

country’s international trade performance.

Volume Weights

The daily volume traded in the FX market

dwarves the global volume of physical trade.

From this it is possible to make a convincing

argument that the weighting which would be

really important would be to weight the currency

basket by financial market flows, rather than

bilateral trade.

HSBC Volume-Weighted REERs

Mark McDonald FX StrategistHSBC Bank plc+44 20 7991 [email protected]

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=stwbxuj1rr&n=240077.PDF

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=stwbxuj1rr&n=240077.PDF

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To do this properly would require us to have

accurate FX volumes for all currency pairs

considered in the index. However, these are not

available. The BIS triennial survey of FX volumes

only gives data for a small number of bilateral

exchange rates. However, the volumes are split by

currency for over 30 currencies. From these

volumes we can estimate financial weightings for

each currency. We believe that this gives another

plausible definition for “importance”, and one

which may be more relevant for financial

investors than trade weights. We call this

procedure volume weighting and the indices

produced through this procedure we call the

HSBC volume-weighted REERs.

We would argue that if you are a financial market

investor, the effective value of a currency you

would be exposed to is more accurately

represented by the HSBC volume-weighted index

rather than the trade-weighted index.

Data Frequency

This is something which is rarely considered

when constructing REERs – inflation data is

generally released at monthly frequency at best so

the usual procedure is to simply create monthly

indices by default. However, some countries

release their inflation data only quarterly. The

usual procedure for these countries is to simply

pro-rata the change over the period. Here there is

an implicit assumption that the rate of inflation

changes slowly. We take this assumption one step

further and assume that it is valid to spread the

inflation out equally over every day in the month.

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USD REER index EUR REER index

80

100

120

140

160

80

100

120

140

160

Jul-95 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 Jul-13

USD Trade-Weighted REER USD Volume-Weighted REER

1996=1001996=100

60

70

80

90

100

110

120

60

70

80

90

100

110

120


EUR Volume-Weighted REER EUR Trade-Weighted REER

1996=1001996=100

Source: HSBC Source: HSBC

JPY REER index GBP REER index

55

65

75

85

95

105

115

55

65

75

85

95

105

115


JPY Trade-Weighted REER JPY Volume-Weighted REER

1996=1001996=100

80

90

100

110

120

130

140

80

90

100

110

120

130

140


GBP Trade-Weighted REER GBP Volume-Weighted REER

1996=1001996=100


HSBC Volume – Weighted REERs

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CAD REER index CHF REER index

80

90

100

110

120

130

140

150

80

90

100

110

120

130

140

150


CAD Trade-Weighted REER CAD Volume-Weighted REER

1996=1001996=100

60

70

80

90

100

110

120

130

60

70

80

90

100

110

120

130


CHF Volume-Weighted REER CHF Trade-Weighted REER

1996=1001996=100


AUD REER index NZD REER index

60

80

100

120

140

160

60

80

100

120

140

160


AUD Trade-Weighted REER AUD Volume-Weighted REER

1996=1001996=100

60

80

100

120

140

60

80

100

120

140


NZD Volume-Weighted REER NZD Trade-Weighted REER

1996=1001996=100


SEK REER index NOK REER index

60

70

80

90

100

110

60

70

80

90

100

110


SEK Trade-Weighted REER SEK Volume-Weighted REER

1996=100 1996=100

70

80

90

100

110

120

130

70

80

90

100

110

120

130


NOK Trade-Weighted REER NOK Volume-Weighted REER

1996=1001996=100


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EUR-USD vs forwards EUR-CHF vs forwards

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16

EUR-USDEUR-USD Forward Forecast

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70


EUR-CHFEUR-CHF Forward Forecast

Source: Thomson Financial Datastream, Reuters, HSBC Source: Thomson Financial Datastream, Reuters, HSBC

GBP-USD vs forwards EUR-GBP vs forwards

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10


GBP-USDGBP-USD Forward Forecast

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00


EUR-GBPEUR-GBP Forward Forecast


USD-JPY vs forwards EUR-JPY vs forwards

60

70

80

90

100

110

120

130

140

60

70

80

90

100

110

120

130

140


USD-JPYUSD-JPY Forward Forecast

85

95

105

115

125

135

145

155

165

175

85

95

105

115

125

135

145

155

165

175


EUR-JPYEUR-JPY Forward Forecast


HSBC forecasts vs forwards

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3 Month Money

2012 2013 2014 2015end period Q4 Q3 Q4 Q1 Q2 Q3 Q4 Q1f Q2f Q3fNorth America x

x US (USD) 0.4 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.3 0.5

x Canada (CAD) 1.3 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2Latin America x x x x x x x x x x x

x Mex ico (MXN) 4.4 3.7 3.4 3.3 3.0 3.0 3.0 3.0 3.0 3.2

x Brazil (BRL) 7.1 9.4 10.1 10.8 10.8 10.9 11.8 12.0 12.0 12.0

x Chile (CLP) 4.9 4.8 4.9 4.0 3.9 3.2 2.9 2.9 2.9 2.9Western Europe x x x x x x x x x x x

Eurozone x 0.1 0.1 0.3 0.2 0.2 0.2 0.1 0.1 0.1 0.1Other Western Europe x x x x x x x x x x x

x UK (GBP) 0.9 0.5 0.5 0.6 0.6 0.6 0.6 0.6 0.7 0.7

Norw ay (NOK) 1.9 1.7 1.7 1.7 1.8 1.7 1.9 1.9 2.0 2.0

x Sw eden (SEK) 1.3 1.2 0.9 0.9 0.7 0.5 0.3 0.3 0.1 0.1

x Sw itzerland (CHF) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0EMEA

Hungary (HUF) 5.8 3.6 3.0 2.7 2.3 2.1 2.1 1.8 1.7 1.7

Poland (PLN) 4.1 2.7 2.7 2.7 2.7 2.4 2.1 2.1 2.1 2.1

Russia (RUB)* 7.5 6.8 7.2 9.1 9.5 10.6 28.0 20.0 18.5 16.0

Turkey (TRY) 5.5 6.9 7.8 11.5 8.3 9.3 8.5 8.5 8.5 8.5

South Africa (ZAR) 5.2 5.4 5.2 5.6 5.6 6.0 5.9 5.9 5.9 6.4Asia/Pacific x x x x x x x x x x x

x Japan (JPY) 0.2 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1

x Australia (AUD) 3.0 2.6 2.6 2.7 2.7 2.7 2.7 2.8 3.0 3.3

x New Zealand (NZD) 2.6 2.7 2.9 3.2 3.6 3.7 3.7 3.7 3.9 4.1

North AsiaChina (CNY) 5.5 5.6 5.6 5.5 4.7 4.5 4.2 3.5 3.4 3.3

x Hong Kong (HKD) 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.6 0.8 0.9

x Taiw an (TWD) 0.9 0.9 0.9 0.9 1.9 1.9 0.9 1.0 1.1 1.2

x South Korea (KRW) 2.9 2.7 2.7 2.6 2.6 2.4 2.1 1.9 1.9 1.9

South AsiaIndia (INR) 8.5 9.7 8.7 8.9 8.6 8.5 8.7 8.6 8.4 8.1

x Indonesia (IDR) 5.0 7.2 7.8 8.1 8.2 8.1 7.2 7.0 6.8 6.8

x Malay sia (MYR) 3.2 3.2 3.3 3.3 3.5 3.7 3.8 3.9 3.7 3.7

x Philippines (PHP) 1.4 0.5 0.3 1.0 1.0 1.2 1.8 1.2 1.4 1.6

x Singapore (SGD) 0.4 0.4 0.4 0.4 0.4 0.4 0.5 0.6 0.8 1.0

x Thailand (THB) 2.9 2.6 2.4 2.2 2.2 2.2 2.2 1.6 1.6 1.8

x South Africa (ZAR) 5.2 5.4 5.2 5.6 5.6 6.0 5.9 5.9 5.9 6.4

Notes: * 1-month money. Source: HSBC

Important note

This table represents three month money rates. Due to the dislocation in the three month money markets, these rates may not give a

good indication of policy rates.

Short rates

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7-Jan-15 2014 2015 2016

last Q3 Q4 Q1f Q2f Q3f Q4f Q1f Q2f Q3f Q4f

Latin America vs USD x x x x x x x x x x x x x

Argentina (ARS) 8.55 8.45 8.46 9.00 9.50 10.00 10.50 11.00 11.50 12.00 12.50

Brazil (BRL) 2.70 2.45 2.65 2.70 2.80 2.90 3.00 3.05 3.10 3.15 3.15

Chile (CLP) 617 598 607 618 625 633 640 640 640 640 640

Mex ico (MXN) 14.90 13.43 14.75 14.25 14.50 14.75 14.80 14.85 14.90 14.95 15.00

Colombia (COP) 2450 2025 2377 2300 2400 2450 2500 2525 2550 2575 2600

Peru (PEN) 2.99 2.89 2.98 3.01 3.08 3.14 3.20 3.24 3.28 3.31 3.35

Venezuala (VEF) 6.29 6.29 6.29 23.00 23.00 23.00 42.00 50.00 58.00 66.00 75.00

Eastern Europe vs EUR

Czech Republic (CZK) 27.7 27.5 27.7 27.6 27.3 27.0 27.0 26.5 26.5 26.5 26.5

Hungary (HUF) 320 311 316 310 305 305 305 305 305 305 305

Russia v s USD (RUB) 63.4 39.6 58.3 59.3 61.3 62.1 62.0 62.0 63.4 64.1 64.5

Romanian (RON) 4.50 4.41 4.48 4.40 4.40 4.40 4.40 4.40 4.40 4.40 4.40

Turkey v s USD (TRY) 2.33 2.28 2.34 2.35 2.37 2.40 2.40 2.40 2.40 2.40 2.40

Simple rate

Poland (PLN) 4.31 4.18 4.28 4.10 4.10 4.05 4.05 4.05 4.05 4.05 4.05

Middle East vs USD x x x x x x x x x x x x

Egy pt (EGP) 7.15 7.15 7.15 7.50 7.50 7.50 7.70 7.70 7.70 7.70 7.70

Israel (ILS) 3.97 3.69 3.90 3.95 4.00 4.10 4.10 3.95 3.95 3.95 3.95

Africa vs USD

South Africa (ZAR) 11.74 11.30 11.55 11.70 11.80 12.00 12.00 12.00 12.00 12.00 12.00

Interest rates

Source: HSBC

Emerging markets forecast table

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end period 2013 2014 2015 2016Q4 Q1 Q2 Q3 Q4 Q1f Q2f Q3f Q4f Q1f Q2f Q3f Q4f

Americas x

x Canada (CAD) 1.06 1.10 1.07 1.12 1.16 1.15 1.17 1.19 1.20 1.20 1.20 1.20 1.20

x Mex ico (MXN) 13.09 13.06 12.99 13.43 14.75 14.25 14.50 14.75 14.80 14.85 14.90 14.95 15.00

x Brazil (BRL) 2.34 2.26 2.20 2.45 2.65 2.70 2.80 2.90 3.00 3.05 3.10 3.15 3.15

x Argentina (ARS) 6.52 8.00 8.13 8.45 8.46 9.00 9.50 10.00 10.50 11.00 11.50 12.00 12.50x

Western Europe x x x x x x x x x x

Eurozone (EUR*) 1.38 1.38 1.37 1.26 1.21 1.21 1.19 1.17 1.15 1.14 1.13 1.12 1.12

Other Western Europe x x x x x x x x x x

x UK (GBP*) 1.66 1.67 1.71 1.62 1.56 1.54 1.51 1.49 1.48 1.47 1.46 1.45 1.45

x Sw eden (SEK) 6.43 6.48 6.69 7.22 7.80 7.44 7.56 7.69 7.83 7.89 7.96 8.04 8.04

x Norw ay (NOK) 6.06 5.99 6.13 6.43 7.49 7.27 7.31 7.35 7.39 7.37 7.43 7.50 7.50

x Sw itzerland (CHF) 0.89 0.88 0.89 0.95 0.99 0.99 1.01 1.03 1.04 1.05 1.06 1.07 1.07x

Emerging Europe x x x x x x x x x x

x Russia (RUB) 32.7 35.7 33.6 39.6 58.3 59.3 61.3 62.1 62.0 62.0 63.4 64.1 64.5

x Poland (PLN) 3.01 3.02 3.04 3.31 3.54 3.39 3.45 3.46 3.52 3.55 3.58 3.62 3.62

x Hungary (HUF) 216 223 226 246 261 256 256 261 265 268 270 272 272

x Czech Republic (CZK) 19.8 19.9 20.0 21.8 22.9 22.8 22.9 23.1 23.5 23.2 23.5 23.7 23.7x

Asia/Pacific x

x Japan (JPY) 105 103 101 110 120 122 124 126 128 128 129 129 130

x Australia (AUD*) 0.89 0.93 0.94 0.87 0.82 0.82 0.80 0.79 0.78 0.77 0.76 0.75 0.75

x New Zealand (NZD*) 0.82 0.87 0.87 0.78 0.78 0.76 0.75 0.74 0.73 0.73 0.72 0.71 0.71

North Asia x x x x x x x x x x x x x x

x China (CNY) 6.05 6.22 6.20 6.14 6.21 6.16 6.18 6.20 6.22 6.24 6.26 6.28 6.30

x Hong Kong (HKD) 7.75 7.76 7.75 7.76 7.75 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80

x Taiw an (TWD) 29.8 30.5 29.9 30.4 31.6 31.1 31.3 31.7 32.0 32.1 32.2 32.3 32.4

x South Korea (KRW) 1056 1065 1011 1058 1093 1120 1140 1150 1160 1160 1170 1170 1180x South Asia x x x x x x x x x x x x x x

India (INR) 61.8 60.0 60.1 61.9 63.2 62.0 62.5 63.0 63.0 63.5 63.5 64.0 64.0

x Indonesia (IDR) 12170 11360 11855 12175 12430 12300 12400 12500 12600 12700 12700 12800 12800

x Malay sia (MYR) 3.28 3.26 3.21 3.28 3.50 3.42 3.47 3.52 3.57 3.59 3.61 3.63 3.65

x Philippines (PHP) 44.4 44.8 43.7 44.9 44.7 44.8 45.0 45.2 45.4 45.6 45.7 45.8 45.9

x Singapore (SGD) 1.26 1.26 1.25 1.28 1.32 1.32 1.33 1.34 1.35 1.36 1.37 1.38 1.38

x Thailand (THB) 32.8 32.4 32.5 32.4 32.9 32.8 33.1 33.4 33.7 33.8 33.9 34.0 34.1

Vietnam (VND) 21080 21080 21329 21205 21380 21250 21500 21500 21750 22000 22000 22000 22000

Africa x x x x x x x x x x x x x

x South Africa (ZAR) 9.24 10.52 10.63 11.30 11.55 11.70 11.80 12.00 12.00 12.00 12.00 12.00 12.00

Source HSBC

Exchange rates vs USD

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end period 2013 2014 2015 2016

Q4 Q1 Q2 Q3 Q4 Q1f Q2f Q3f Q4f Q1f Q2f Q3f Q4fVs euro xAmericas x

x US (USD) 1.38 1.38 1.37 1.26 1.21 1.21 1.19 1.17 1.15 1.14 1.13 1.12 1.12

x Canada (CAD) 1.47 1.52 1.46 1.42 1.41 1.39 1.39 1.39 1.38 1.37 1.36 1.34 1.34Europe x

x UK (GBP) 0.83 0.83 0.80 0.78 0.78 0.79 0.79 0.79 0.78 0.78 0.78 0.77 0.77

x Sw eden (SEK) 8.86 8.92 9.16 9.11 9.44 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00

x Norw ay (NOK) 8.36 8.25 8.40 8.12 9.06 8.80 8.70 8.60 8.50 8.40 8.40 8.40 8.40

x Sw itzerland (CHF) 1.23 1.22 1.21 1.21 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20

x Russia (RUB) 45.1 49.1 46.0 50.0 70.5 71.8 72.9 72.7 71.3 70.7 71.6 71.8 72.2

x Poland (PLN) 4.16 4.17 4.16 4.18 4.28 4.10 4.10 4.05 4.05 4.05 4.05 4.05 4.05

x Hungary (HUF) 297 307 310 311 316 310 305 305 305 305 305 305 305

x Czech Republic (CZK) 27.3 27.4 27.4 27.5 27.7 27.6 27.3 27.0 27.0 26.5 26.5 26.5 26.5Asia/Pacific x x x x x x x x x x x x x x

x Japan (JPY) 145 142 139 138 145 148 148 147 147 146 146 144 146

x Australia (AUD) 1.54 1.49 1.45 1.45 1.48 1.48 1.49 1.48 1.47 1.48 1.49 1.49 1.49

x New Zealand (NZD) 1.67 1.59 1.56 1.62 1.55 1.59 1.59 1.58 1.58 1.56 1.57 1.58 1.58

Vs sterling x x x x x x x x x x x x x xAmericas x x x x x x x x x x x x x x

x US (USD) 1.66 1.67 1.71 1.62 1.56 1.54 1.51 1.49 1.48 1.47 1.46 1.45 1.45

x Canada (CAD) 1.76 1.84 1.82 1.82 1.81 1.77 1.77 1.77 1.77 1.76 1.75 1.74 1.74Europe x x x x x x x x x x x x x x

x Eurozone (EUR) 0.83 0.83 0.80 0.78 0.78 0.79 0.79 0.79 0.78 0.78 0.78 0.77 0.77x

x Sw eden (SEK) 10.65 10.80 11.44 11.71 12.15 11.46 11.41 11.46 11.55 11.60 11.60 11.64 11.64

x Norw ay (NOK) 10.05 9.99 10.49 10.43 11.66 11.20 11.03 10.95 10.91 10.82 10.82 10.87 10.87

x Sw itzerland (CHF) 1.47 1.48 1.52 1.55 1.55 1.53 1.52 1.53 1.54 1.55 1.55 1.55 1.55Asia/Pacific x x x x x x x x x x x x x x

x Japan (JPY) 174 172 173 178 187 188 187 188 189 188 188 187 188

x Australia (AUD) 1.86 1.80 1.81 1.86 1.91 1.88 1.89 1.89 1.89 1.91 1.92 1.93 1.93

x New Zealand (NZD) 2.01 1.92 1.96 2.08 2.00 2.03 2.01 2.01 2.02 2.01 2.02 2.04 2.04

Source: HSBC

Exchange rates vs EUR & GBP

62


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Notes

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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: David Bloom, Daragh Maher, Paul Mackel, Robert Lynch, Clyde Wardle, Stacy Williams, Mark McDonald, Murat Toprak, Marjorie Hernandez, Dominic Bunning, Ju Wang, Joey Chew, James Steel and Howard Wen

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[442705]

Currency

OUTLOOKMurat ToprakFX Strategist, EMEAHSBC Bank plc+44 20 7991 [email protected]

Main contributors

Disclosures and Disclaimer This report must be read with the disclosures and analystcertifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Marjorie HernandezFX Strategist, Latin AmericaHSBC Securities (USA) Inc.+1 212 525 [email protected]

Joey ChewFX Strategist, AsiaThe Hongkong and Shanghai Banking Corporation Limited+852 2996 [email protected]

Clyde WardleEmerging Markets FX StrategistHSBC Securities (USA) Inc.+1 212 525 [email protected]

Dominic BunningFX Strategist, AsiaThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Robert LynchHead of G10 FX Strategy, AmericasHSBC Securities (USA) Inc.+1 212 525 [email protected]

Ju WangFX Strategist, AsiaThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

David BloomGlobal Head of FX ResearchHSBC Bank plc+44 20 7991 [email protected]

Daragh MaherFX Strategist, G10HSBC Bank plc+44 20 7991 [email protected]

Stacy WilliamsHead of FX Quantitative StrategyHSBC Bank plc+44 20 7991 [email protected]

Paul MackelHead of Asian FX ResearchThe Hongkong and Shanghai Banking Corporation Limited+852 2996 [email protected]

Mark McDonaldFX Quantitative StrategistHSBC Bank plc+44 20 7991 [email protected]

The USD bull run has further to go in 2015. This should be largely positive, particularly for those developed economies facing a deflation threat. Yet markets will also need to be mindful of the risks of excessive USD strength. We address these two contrary but inter-related aspects of our bullish USD view – the two faces of USD strength.

2015 currency outlooks We provide single-page summaries of our 2015 outlook for the most actively traded currencies in G10, Asia, CEEMEA and LatAm as well as precious metals.


MacroCurrency Strategy

January 2015

Play Video with David Bloom and Daragh MaherIssuer of report: HSBC Bank plc

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