USD: Still Bearish USD. Bearish.
We believe USD positions will continue to unwind as weak US data put Fed rate hikes in doubt and the search for yield continues. We expect Yellen to reaffirm the view of the core of the FOMC that patience is prudent, and better inflation and growth data are needed before being more confident about additional rate increases.
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Certainly, the Fed would like to have optionality in hiking rates this year if the data strengthens so we don't expect December to be priced out much further than currently but still see scope for USD weakness in the near term as EM continues to turn around and EUR and JPY struggle to weaken. A hawkish Fed is a risk to our view.
EUR: Staying in Demand. Bullish.
In the past week, EURUSD has caught up with the USD weakness. We expect more upside for the currency pair, to 1.15, as EURUSD has broken the 1.1255 level of the May downward trend. EUR continues to be supported by rising real yields and banks' weak balance sheets reducing their ability to export long-term capital to counteract the inflows from the EMU's current account surplus. Rising US LIBOR also increases USD funding costs and could help strengthen the EUR if EMU banks increase repatriation flows as Eurozone banks are one of the largest participants in the US prime money market. We promote buying EUR against USD and particularly against GBP.
JPY: Staying Bullish. Bullish.
With the fiscal and monetary policy announcements out of the way (and with both having disappointed), we expect JPY to resume the upward trend against USD it has maintained since the beginning of the year. With the BoJ fuelling expectations that the negative interest rate policy may be lifted at its next meeting in a comprehensive review of its current policy, should nominal JPY yields continue to rise, real yields could increase further to strengthen JPY. FX hedging costs have risen (with hedged foreign bond yields, particularly USD, fluctuating around 0), but we don't expect an offsetting increase in unhedged flows. We expect USDJPY to continue to decline.
GBP: Weighed by BoE. Bearish.
We stick to our bearish GBP view and promote selling against EUR, but would wait for better levels to sell GBPUSD*. While GBP has appreciated on the back of strong post-Brexit UK CPI, employment and retail sales numbers, we would use the rally to sell. The BoE has made it clear that it expects inflation to overshoot and will maintain a loose monetary policy to stimulate the economy. Therefore, we do not expect the data strength to stop the BoE from easing further. With inflation rising and nominal yields declining, UK's real yields are falling rapidly, making GBP unattractive.
CHF: Strength Against USD. Neutral.
We expect CHF to continue strengthening against USD, helped by rising real yield differentials. USDCHF has broken the 0.97 handle and is currently trading approximately 1% away from the next support level of around 0.95. CHF faces similar dynamics to the EUR, namely rising real yields, commercial demand from its current account surplus and weak banks' balance sheets reducing their ability to export long-term capital, helping to support the currency. Therefore, against EUR, CHF should remain relatively stable. This week, we watch export numbers.
AUD: China Risks Loom. Bullish.
We believe recent China data will impact AUD over coming months, pointing to slower China growth and weakness in China-linked commodity prices. However, AUD may still find support amidst the search for yield. Its reaction to the rate cut is telling, given it ended the day over 1% higher against USD despite the rate cut not being fully priced in. Mixed employment data this week further complicate the domestic data picture amidst better growth but still very weak inflation. RBA Gov. Stevens' outgoing speech also gave no indication that further easing is imminent. Our long-term bearish view remains, but is contingent on the housing cycle turning and slowing growth in China forcing the RBA to cut 50bp further in 1H17.
NZD: Bullish vs. USD Neutral.
Recent retail sales and employment data reinforce the strong domestic growth environment, but NZD's rise continues to complicate the inflation outlook. In the short term, we expect NZD to outperform USD amidst the continued search for yield. We are still focused on the RBNZ in the medium term, particularly as two "scenarios" in the latest MPS forecast substantially more easing based on either lower inflation expectations or a flat TWI (as opposed to forecasted depreciation). With increased risks each scenario is fulfilled, we believe further rate cuts are likely and the RBNZ will eventually act more forcefully against NZD. But with the next MPS not until November, it will take time for this narrative to play out.