USD, EUR, JPY, CAD, AUD, NZD: Weekly Outlook - Morgan Stanley

USD: Best House in a Bad Neighbourhood. Bullish.

Unlike in prior tightening cycles, we expect USD to continue appreciating following liftoff a few weeks ago. While the US economy does not look particularly strong, the most important elements of the economy (employment, services, housing) are humming along just fine. The US will remain the ‘best house in a bad neighbourhood’ and will attract capital flows from abroad.

EUR: A Break in the Risk Link? Neutral.

EUR has continued to weaken even as risk sentiment deteriorated in recent days. We think this is related to disappointing inflation prints, which increase the likelihood that the ECB will be forced to do more. Also, IMF COFER data suggest reserve managers continue to diversify out of EUR. This process may have accelerated after the ECB drove rates further into negative territory. EUR should continue to weaken versus JPY over the course of the year.

JPY: 2016 All Star. Bullish.

Our bullish JPY view appears to be playing out even faster than we expected. Weak risk appetite has supported repatriation to the safe haven JPY. But more than that, we think there is an underlying policy shift in Japan away from monetary and toward fiscal policy. The BoJ is unlikely to ease further, with greater focus being placed on fiscal stimulus and encouraging corporates to pay higher wages and invest onshore. We think the market underappreciates potential for pension liquidation by the retiring Japanese population, which will force some repatriation of foreign assets and make flows more two-way than in recent years. 

CAD: Will the BoC React? Bearish.

Ongoing softness in oil prices continues to weigh on CAD, although it is not the whole story. Other data weakened in 4Q, including manufacturing and non-commodity trade. We expect the central bank will shift toward a more dovish stance following its meeting on the 20th with a risk of cutting rates. The market continues to price in too little probability of easing in 1H16.

AUD: It’s Not Over. Bearish. 

Concerns about China’s growth, weak commodity prices and a general deterioration of risk sentiment have led to a sharp fall in AUD in these early days of 2016. While the speed of the decline may slow, we still expect further AUD weakness as external developments have knock-on effects on the domestic economy. Macroprudential tightening is set to weigh on the housing market, which has been one bright spot of Australia’s economy. As such, we expect 50bp of easing from the RBA in the first half, which is far from priced.

NZD: Breaking Lower. Bearish. 

NZDUSD has broken out of the bottom end of the trend channel, supporting further downside. Being a high-beta, less liquid currency, NZD is particularly vulnerable in times of risk-off. In addition, the dairy auctions are showing signs of weakness once again. With the EU bringing more milk supply to market and a slowing Chinese economy, NZD is vulnerable. Lower inflation expectations could bring further RBNZ rate cuts back on the table too."