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

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

4 July 2016, 19:52
Vasilii Apostolidi

USD: Divergent USD. Bullish.

USD should weaken further vs. EUR and JPY but rise vs. high-risk EM currencies. The market is pricing no Fed rate hike until late 2018 and a non-negligible probability of a cut this year.

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While we expect an on-hold Fed for some time, we think USD will remain supported against high risk EM and commodity currencies as long as the Fed retains its hiking bias. Upcoming US data will be key, particularly this week's NFP report, to show whether 2Q growth will continue into 3Q despite tightening financial conditions and risks of a slowing labor market. USD is likely to weaken against EUR and JPY, however, especially if risk appetite weakens further and the ECB and BoJ find difficulty in lowering rates further.

EUR: EUR Is the New JPY. Bullish. 

It would be difficult to weaken the EUR, in our view. Falling investment returns globally have led to EMU-based entities' repatriating foreign assets, turning into EUR buyers. The risk aversion of EMU financial institutions also results in the lack of long-term capital outflows counteracting EUR buying from the EMU's current account surplus. With German bond yields falling into negative territory, the room for nominal yields to move lower is limited. In a deflationary environment, a fall in inflation expectations outpacing a decline in nominal yields has risen, which will push real yields up in support of EUR. We remain constructive on EURGBP positions.

JPY: Staying Strong Bullish.

Despite the risk rally this week, USDJPY has once again failed to participate, reaffirming our call that USDJPY will continue to grind lower. The UK's vote to leave has helped USDJPY break below 100, fuelling speculation of FX intervention by the MoF. However, we don't expect FX intervention given political risks, particularly contention by the US that the moves have been "orderly" (implying intervention would not be condoned) so the fundamentals will continue to drive USDJPY.

GBP: Sell Corrective Rally. Bearish.

We think any GBP corrective upside should be capped by last week's 1.3560 recovery high. The uncertainty around the UK's political leadership and EU exit will continue to weigh on inward FDI flows and GBP. The UK's high debt level and declining productivity growth may result in falling returns expectations, increasing the incentive for balance sheet consolidation, suggesting higher savings, lower bond yields and hence lower GBP. We continue to promote selling GBP against JPY, EUR and USD.

CHF: Real Yield Support. Bullish.

CHF remains supported by real yield differentials. A large part of Switzerland's sovereign yield curve is in negative territory, reducing the room for nominal yields to fall further. In a deflationary environment, inflation expectations are likely to fall faster than nominal yields, driving real yields higher to support the currency. The uncertainty lingering from the UK's exit from the EU may also continue to support CHF. The SNB will likely intervene if EURCHF appreciates too quickly, but a slow grind higher should be acceptable.

CAD: Fundamentally Bearish. Bearish.

We stay bearish on CAD as we believe the market isn't pricing enough downside risks to the outlook, though we see scope for further strengthening if risk performs well. The BoC has maintained an upbeat tone with Poloz arguing that the economy is making "real progress" and supporting a wait-and-see approach to the recent wildfires and trade data. However, we are still skeptical of Canada's rotation away from the resource sector, with April's trade data showing little rebound after a sharp reversal of export growth in the last few months and few promising industries which can be the engines of growth in the future.

NZD: Risk-Dependent. Neutral.

New Zealand's latest GDP print has surprised to the upside, driven by strong consumption growth, supporting our view that NZD will continue to be supported by strong migration. However, while NZD will likely be supported in the risk rally, we believe that the RBNZ will continue to face the divergent effects of rising house prices (pushing it to keep rates on hold or raise them) and a too strong exchange rate (forcing further easing). With the NZD TWI at 1 year highs (and well above their forecasts), we are looking to sell the currency as the central bank appears ready to act. 2Q CPI released in July is the next major data point to watch and weak print could solidify the odds of a cut in August.

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