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

EUR: Heading Higher. Bullish. 

We remain bullish on EUR and stick to our quarter-end target of 1.16 for EURUSD. The Eurozone economy has held up well post-Brexit, supported by the recent release of Eurozone August flash PMIs. This increases the risks of the ECB not having to ease significantly beyond what markets have priced.

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Even if the ECB extends its QE programme or cuts rates further, we think it will not be able to push down long-term bond yields substantially to weaken the currency, as Eurozone bond yields are already low or negative. Data weakness in the US has also caused the spread between the Eurozone and US economic surprise indices to widen significantly since July, reaching levels last seen in May when EURUSD traded at 1.15, further supporting our argument for a higher EURUSD.

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: Rally to Continue. Neutral.

GBP has rallied in the past week as UK economic data has printed stronger than expected, reducing market fears about a sharp slowdown in the post-Brexit UK economy. With CFTC data showing GBP short positioning at a historic high, we think there is scope for GBP to continue rallying towards 1.3450 as these short positions are closed. Should economic data continue to outperform, the current 8bp BoE rate cut priced by the rates market may also be priced out, supporting the GBP further. Recent data has been indicating signs of the weaker GBP attracting foreigners to buy GBP assets, and we would monitor this trend to determine if the currency can be supported by such flows.

CHF: Strength Against USD. Neutral.

We continue to project CHF strength against USD, driven by a weaker USD and rising real yield differentials. 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, providing support for the currency. The Swiss economy may also receive a boost from a weaker GBP, as increased tourist demand for luxury goods in the UK has reportedly helped Swiss watch exports to the UK rise by 13.4% in July. This week, we watch the KOF leading indicator.

AUD: Sell Crosses. Neutral.

We believe recent China data will impact AUD over coming months, pointing to slower China growth and weakness in China-linked commodity prices. ,AUD may still find support against USD but we like selling it on the crosses. This week's worse than expected construction data poses downside risks to 2Q growth, and mixed employment data further complicates the domestic data picture. RBA Gov. Stevens' outgoing speech also gave no indication that further easing is imminent but we expect the China slowdown as well as a higher TWI to increase market focus on rate cuts down the line. Our long-term bearish view remains and 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. Bullish.

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 and other commodity currencies 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 include substantially more easing based on either lower inflation expectations or a flat TWI (as opposed to forecasted depreciation). With increased risks that one of these scenarios 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.