The case for rising USD real rates. Falling DM productivity rates in conjunction with demographics boosting savings relative to consumption and globalisation has allowed DM real rates to decline over the past three decades. Lower real US rates were an important factor driving US financial and real sector investment abroad providing the fuel for the EM economic growth engine.
This trend may terminate now with globalisation slowing and the demographically related increase of savings relative to investment peaking. US productivity is the next factor to look at. Productivity has a structural and a cyclical component. Higher investment will boost cyclical productivity suggesting US capital demand and US real rates going up, both working in favour of the USD.
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Anticipated EUR weakness. The EUR will not withstand these pressures either and we reiterate our view calling the EUR the ‘mini JPY'.
Inner EMU sovereign bond spreads have widened with Italy, Portugal and Greece taking the lead, pouring cold water on the idea the ECB may head towards an early reduction of its monetary accommodation. Greece and its EU creditors continued to struggle on Thursday to reach agreement on a key review needed for Athens to unlock new loans and avoid a descent into renewed financial turbulence. Italy’s economy struggles with its real rates which are too high relative to its ailing investment outlook, leaving the ECB with little other choice but to create conditions under which Italian real rates can fall. Tightening its policy too early may come with too high costs putting Italy under even more stress.
Hawkish comments from ECB members representing core countries (Mersch, Weidmannn, Lautenschlaeger) may be dismissed as the ECB directorate runs the show and here dovishness has prevailed. The EMU’s core may develop inflation while Italy may prevent the ECB from acting ahead of the curve, creating an ideal environment for EUR weakness.
MS maintains a short EUR/USD position from 1.0650 targeting 0.99.*