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

USD: Buy USD vs Commodity. & EM Currencies. Bullish.

The Fed's broad USD index has rallied by 2% since the start of May, driven by a reduction of extreme short positioning in USD and a correction in commodity markets which we expect to continue. With the Fed's Dudley suggesting that two rate hikes this year remains reasonable, the current underpricing of the Fed by markets will need to adjust, supporting USD strength. This week's CPI numbers and FOMC minutes will be important in influencing markets' expectations of the Fed.

EUR: Low Yielders to Outperform. Neutral.

We believe EUR will outperform high beta EM and commodity currencies as USD rallies, given the ECB's inability to combat global disinflationary forces. In this environment, falling inflation expectations increase real yields as nominal yields are difficult to push lower with much of the yield curve negative. We believe that EUR is still likely to be negatively impacted by political developments in the future with Brexit a potential catalyst in the near term.

GBP: Looking Beyond Brexit. Bearish.

In the short term, we expect GBP to continue to come under selling pressure due to Brexit uncertainty, as the polls indicate a close race between the Remain and Leave camps and we think little of this has been priced in. Looking beyond Brexit, the UK economy is also showing signs of fatigue, as evidenced by the weak manufacturing numbers recently and the BoE's downward revision of its GDP forecast. As such, we expect nominal yields to work against the GBP and like selling GBP against USD.

CAD: Stay Short CAD. Bearish

Data in Canada continued to disappoint this week with a poor capex intentions survey pointing to a large investment drag from energy and manufacturing in 2016. This follows last week's poor trade data which showed non-commodity export volumes falling an additional 2% in March after their nearly 5% fall in Feb., reversing all the improvement since 3Q15 and raising serious doubts about the chance for an export-led recovery. These factors, in addition to CAD's strong appreciation and production taken offline due to the tragic wildfires, pose large downside risks to 2Q growth and increase the probability that the BoC starts discussing downside risks to the outlook. We like short CAD positions.

AUD: Commodities Drag. Bearish.

The recent sharp fall in iron ore and rebar prices have shown that commodity prices are overstretched due to speculative activity and more correction can come, which will weigh on the AUD. The rebalancing of Australia's economy from the highly paid mining sector to lower-paying services sector have reduced wages and inflation expectations, paving the way for more rate cuts by the RBA. We stay bearish on AUD and like selling against JPY and USD.

NZD: Looking to Sell. Bearish.

We like selling NZD in this current USD rally as we expect high carry commodity currencies to underperform. NZD has benefited in recent days as the RBNZ's financial stability report pointed to rising house prices as a risk and pointed to the possibility of more macroprudential policies. While this, along with some better than expected data, has caused the market to price out the probability of RBNZ cuts, we expect this to reverse. The NZD TWI remains too high and with our expectation for commodity prices to fall as well as the RBA's recent dovish turn, we believe the RBNZ will stay dovish and limit currency strength.