USD, EUR, JPY, GBP, CHF, CAD, AUD: Weekly Outlook - Morgan Stanley
USD: Bullish USD. Bullish.
We are increasingly believing the USD is moving back to its long-term bullish trend driven by widening yield differentials and output gap divergence. US data has improved, election uncertainties have subsided and risk appetite remains fragile, all factors which point to USD appreciation. We expect USD strength to be most pronounced against low yield G10 (JPY, SEK, GBP) while EM currencies may stay relatively resilient.
EUR: EUR Crosses Holding Up. Neutral.
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EURUSD has come under selling pressure on the back of broad USD strength and we expect this could continue as USD continues to strengthen. However, we think EUR will remain supported on the crosses. Recent ECB commentary has cautioned about low/negative interest rates, suggesting that there may be few cuts left in the ECB's toolbox. Global and EMU inflation also ticked up in September which, if sustained, could lead to ECB tapering talk coming back into focus and a reduction in the pricing of rate cuts (12bp cut priced by Apr 2017), providing support for the currency. Should risk appetite turn sour, EUR crosses will also remain supported.
JPY: JPY Weakness Building. Bearish.
We expect further USDJPY strength as long JPY positions unwind and Japan moves toward a more expansionary fiscal stance. Consensus remains bullish JPY and long positioning is near record levels. The new BoJ policy is more sustainable than previous policies and gives the Bank more flexibility to steepen the curve, thus supporting bank profitability. The BoJ's policy all sets the stage for additional long-term bond issuance and fiscal stimulus over the next few months. Additionally, unhedged outflows are likely to be increased over the coming months given the increased hedging costs (widened USDJPY basis), further supporting USDJPY. We added a long USD/JPY limit order to our strategic portfolio.*
GBP: Short Covering Rally Before Sustained Weakness. Neutral.
We are changing our forecasts to expect more GBPUSD weakness in coming quarters and little recovery next year. However, we expect some short-term strength due to the market's large short positioning and signs of the government rethinking its hard stance on Brexit, including allowing Parliament to vote on Brexit negotiations. Any improvement in the news flow gives GBPUSD upside potential to 1.2685, and should the government be able to leave the impression that EU market access remains one of its main objectives, GBPUSD could rally to 1.3450. This week, there are many major data releases including CPI, unemployment and retail sales, but we think any positive surprise will provide short-lived support for the currency as GBP is predominantly driven by politics currently. Over the medium term, we expect investment weakness and political uncertainty to push GBP lower.
CHF: Weaken Against USD. Neutral.
Given our projection for USD strength, particularly against the low yielding currencies, we think USDCHF can continue to move higher. Should risk appetite be hit by a stronger USD and yield curves steepening globally, CHF may receive a boost. With the SNB standing ready to intervene, the downside for EURCHF is likely to be limited to 1.0750, keeping the pair within its 1.0750-1.11 trading range. Even though Switzerland's CPI has recovered in 2016, we do not expect the SNB to change policy anytime soon, given the SNB lowered its 2017 and 2018 inflation forecasts in its last statement and the IMF supporting the SNB's use ofvery negative interest rates and FX interventions to support inflation.
CAD: CAD Underperformance. Bearish.
We remain bearish on CAD ahead of next week's BoC meeting where we expect a dovish outcome. In its previous meeting, the BoC stated that inflation risks have tilted somewhat to the downside and growth may be somewhat lower than anticipated in July, softening the hawkish tone that it had been adopting so far despite weak economic data. Deputy Gov. Wilkins reiterated these themes in her speech last week. This increases the possibility of the BoC cutting rates over the next few months, particularly in light of weakening inflation data. 3Q growth expectations have improved somewhat in recent weeks due to better July GDP and a narrower trade deficit but we are still skeptical the BoC's forecasts will be reached. Given the markets are pricing only a few bps of rate cuts for this year, and CAD has the largest long positioning in G10, we think further data weakness could weaken CAD significantly. We like selling CAD against other commodity currencies.
AUD: Vulnerable to Fed and Risk. Neutral.
We believe AUD may outperform other commodity currencies but the currency remains vulnerable to Fed hikes and a fall in risk appetite. Data has been strong lately, including last week's retail sales and trade data, and Gov. Lowe shows no greater inclination to ease than the previous governor. We think the bank will remain on hold throughout 2016 and record building approvals data is another sign that risks of further rate cuts to financial stability remain high. Nonetheless, AUDUSD will likely be driven by Fed rate hike probabilities as well as general risk appetite and we prefer expressing AUD longs against NZD or CAD.
