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

USD: Lower USD For Now. Bearish.

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

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Fed is largely okay with current market pricing, keeping US yields low. 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. NFP last week was strong on the headline but underlying details were weaker, good enough to reduce fears of a recession but not strong enough to bring the Fed back into play. This supports our bearish USD view.

EUR: Focus on ECB. Bullish.

We remain bullish on EUR. This week, the ECB rates decision will be a key risk event. We do not expect EUR to weaken on the back of this, given our economists are not expecting a rate cut which the currency responds most to. Any additional QE measures will be ineffective in weakening the EUR as it does not lower long-term bond yields. Italian bank shares have also recovered as equity markets are pricing in a pragmatic solution for the banks without triggering a full-scale bail-in, but EUR is still trading at a discount when measured using real yield differentials. Therefore, we think there is more upside potential and promote buying against GBP and USD.

JPY: Waiting for BoJ. Neutral.

With FX markets responding to headlines on debt monetisation in Japan, but the authorities not revealing specific details on what measures they will implement, we think JPY will be volatile and will wait for the risk events before selling USDJPY again. We will watch the outcome of the BoJ meeting on 29 July and the announcement of the supplementary budget before re-entering any JPY trades. If the authorities do not implement debt monetisation, then Japanese real yields will continue to rise as current monetary policy tools are no longer effective in boosting inflation expectations, in our view. We will then look to re-enter long JPY positions.

GBP: Fade the Rally. Bearish

GBP rallied after the announcement of the new Cabinet reduced political uncertainty and BoE's inaction surprised markets. However, we would suggest fading any rallies. The markets have been focused on upbeat headlines suggesting resilient retail demand post-Brexit, but we think it is premature to make any judgement from so few data points. GBP also faces the risk of the BoE delivering a bigger-than-expected easing package in August. We think any GBPUSD upside is limited to 1.35, while the downside can reach 1.25 in the coming months. Given this asymmetric risk profile, we remain bearish on GBP and like expressing this via long EURGBP positions.*

CAD: Turning Neutral. Neutral.

We are turning back neutral CAD following the surprisingly hawkish BoC meeting. Despite revising down its growth forecast and pushing back the date of output gap closure, the BoC maintained a neutral tone and showed no willingness to ease anytime soon. Based on rhetoric from the press conference, they appear more worried about housing than their forecasts imply. They also emphasized a willingness to look through short-term disappointment on trade data and remained confident that data would eventually rebound. However, by forecasting a strong rebound in 3Q and 4Q growth, the BoC has set itself a high bar: if growth fails to meet these optimistic expectations, easing may come back on the table. For now, we don't like trading CAD from the short side and believe it can appreciate further from here, though positioning remains very long.

AUD: Bullish For Now. Bullish.

Coupled with USD depreciation and investors’ continued hunt for yield, AUD may stay relatively well supported in the near term. While we believe the RBA will eventually cut rates in August, there is no catalyst until the 2Q CPI report in a few weeks. Until then, we expect AUD to perform well particularly in light of the decent employment report this week. In addition, political risks have now reduced for the AUD as a majority coalition government is likely. Our long-term bearish view, however, remains unchanged. and we expect more rate cuts to push AUD lower over the medium term.

NZD: Supported from consumption and no rate cut. Neutral.

NZDUSD should continue to trade higher in this environment of a weaker USD thought NZD should underperform AUD. The announcement of a economic update, following the upcoming CPI report but ahead of the next RBNZ meeting signals a worry over the level of the exchange rate and increases risks of rate cuts in either outcome. A weaker CPI indicates a need for further monetary easing while a strong CPI could push the exchange rate to even more uncomfortable levels (though not necessarily inducing rate cuts like the former scenario). However, housing remains an issue and deputy Governor Wheeler reiterated his stance on macro prudential measures, suggesting that investors will likely have tighter rules by the end of the year. We continue to expect strong migration to support housing and local consumption.