USD: Lower USD For Now. Bullish.
We expect USD will weaken in coming weeks as low US yields and a better risk environment support carry trades and commodity currencies. The June minutes and Dudley's remarks suggest the Fed is largely okay with current market pricing, keeping US yields low.
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At the same time, Brexit hasn't been systemic for broader risk markets and as volatility falls, risky assets should remain supported. We likely need a bigger global economic downside surprise, out of China or possibly the Eurozone, to shake the current environment.
EUR: Staying Constructive. Bullish.
Recent concerns about Italy and the wider EMU's banking sector have not changed our bullish view on the EUR. We think the probability of an Italian bank rescue is high, as EU authorities will want to reduce the chances of PM Renzi losing the October referendum to keep the currency union intact. This also supports our stance that the weak balance sheets of EMU's financial institutions will reduce their willingness to invest overseas, resulting in longterm capital exports not being sizeable enough to counteract inflows from the EMU's current account surplus, supporting EUR strength.
JPY: Staying Strong. Bullish.
USDJPY has continued to grind lower and in an environment of a weakening USD, we reaffirm our call that USDJPY will continue to fall. 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. Weakening realized inflation and inflation expectations as well as economy activity indicators are putting pressure on authorities to enact further fiscal and monetary policy measures. However, we continue to believe additional expansion of current tools is unlikely to change the trend in USDJPY, which will be driven lower by real yield differentials, hedging flows and risk appetite.
GBP: All Eyes on BoE. Bearish.
The upcoming BoE rates decision will be key for FX investors. The UK sovereign yield curve is still steep enough for conventional monetary policy tools to reduce nominal and real yields to weaken the GBP, hence further monetary easing hinted by the BoE points to more downside potential. Our economists are expecting the BoE to cut rates by 25bp at the meeting. Given markets are currently pricing only an 18bp cut, GBP could weaken further. Our favored way of expressing this bearish GBP view is through long EURGBP positions.*
CHF: Real Yield Support. Bullish.
We remain bullish on CHF due to support from real yield differentials. With sovereign bond yields falling globally, Switzerland's entire sovereign yield curve (up to 50y maturity) is now in negative territory. In this scenario, the downside beta of nominal yields is reduced. With a depreciating RMB, China is exporting deflationary pressures to the rest of the world. This may cause inflation expectations in Switzerland to decline faster than nominal yields, driving real yields higher in support of CHF.
AUD: Selling Rallies. Neutral.
Coupled with USD depreciation and investors’ continued hunt for yield, AUD may stay relatively well supported in the near term. However, we would use a rally to sell, particularly since recent economic data have consistently missed expectations and inflation has remained subdued, which may prompt the RBA to act. In particular, our economists expect a 25bp rate cut at the August meeting, which the markets are currently underpricing (17bp). Political risks have now reduced for the AUD as a majority coalition government is likely. We promote selling AUD against NZD.
NZD: Supported from consumption and no rate cut. Bullish.
NZDUSD should continue to trade higher in this environment of a weaker USD and potentially no more near-term rate cuts from the RBNZ. Deputy Governor Wheeler reiterated his stance on macro prudential measures, suggesting that investors will likely have tighter rules by the end of the year but not suggesting anything new that would indicate that they could cut rates further. A stable CPI print on 17th July should keep the RBNZ away from near term rate cuts. We continue to expect strong migration to support housing and local consumption. NZDUSD will likely cross the previous high at 0.73 this week.