It appears that Goldilocks and the USD bears are playing for the same team at present. The global recovery seems to be strong enough to fuel demand for carry while, at the same time, the US economy is not doing well enough to justify another Fed hike. Investors remain rather relaxed about the prospects for further tightening despite improving US data, stabilising inflation expectations and still-accommodative monetary conditions. As a result, USD is struggling to perform against both commodity and risk-correlated as well as safe-haven G10 currencies.
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We doubt that this can be sustained over the longer term. The USD trend-appreciation has stalled, global financial conditions have eased considerably further and the US recovery is continuing even if it lacks much vigour. All that should allow the Fed to normalise policy further in December. Growing prospects for Fed tightening can put an end to the risk rally given that a big chunk of the recent gains in AUD, NZD, CAD and NOK can be traced back to the expectations of enduring Fed dovishness. With that gone, valuations will have to adjust.
Given how sceptical the markets are about future Fed hikes, the bar for potential ‘hawkish’ surprises from next week’s Fed minutes and US CPI data as well as Yellen’s speech at Jackson Hole on 26 July should be relatively low.
That said, we are conscious of the risk that a further improvement in USD fundamentals may not trigger a sustained currency rally just yet. Even so, we believe the next leg higher in USD is a matter of time and have a slight preference to express our long-term bullish view vs commodity G10 currencies rather than EUR and JPY.
The BoE’s recent aggressive easing measures have triggered another wave of GBP selling in the markets. Despite that, we believe that extreme market short positioning and evidence of GBP undervaluation should contain the underperformance. Next week’s UK data releases could highlight that consumers have shrugged off the post-Brexit uncertainty while the GBP weakness has fuelled inflation. With many negatives in the price of GBP, the data can help the currency stabilise.
Next week we also have unemployment data out of Australia and New Zealand as well as CPI data and retail sales out of Canada. The impact on CAD, AUD and NZD may depend more on broader USD sentiment and market appetite for carry than the quality of the data, however.