The USD’s recent lack of form is usually attributed to two factors. The first is market positioning, with investors sitting on extensive longs and awaiting more clarity on President Donald Trump’s economic stimulus. A second reason seems to be the fear that protectionism will go hand in hand with a ‘weak USD’ policy. This helps explain the gap between the languishing USD and elevated US rates since the start of the year.
We believe that President Trump will deliver on most of his economic stimulus initiatives, although we may have to wait for more details on the planned tax reform and deregulation. We also think that the ‘conflict’ between Mr Trump’s policies to boost the US economy and his apparent desire to prevent bouts of excessive USD strength is exaggerated. Indeed, we doubt Mr Trump would object to any USD gains so long as they reflect improving US fundamentals.
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We take into account the latest market developments in our updated FX forecasts and, apart from EUR/USD, see somewhat less pronounced USD gains in Q1. The USD outperformance should extend in Q2 and Q3 as improving US data and Fed policy normalisation boost the currency. The gap between the USD TWI and the UST yields and short-term rates should start closing next week. Indeed, the February Fed statement and the US data (NFP) could emphasise the still robust US fundamentals. USD is a buy on dips and we stick with our long USD/CAD position.
Recently, we have also gone short EUR/USD*, expecting FX spot and the EUR–USD rate spread to converge and noting the build-up of credit risk in Eurozone bond markets. Robust market risk sentiment should keep both the EUR and JPY under pressure as well.
That said, next week’s Bank of Japan meeting may support the JPY if it hints at a ‘taper’, given that recent tweaks of its QE programme resulted in a net reduction of the bank’s bond purchases. We stick with our short EUR/JPY position. It is a good hedge for the upcoming political risks in the Eurozone.
The GBP could remain supported ahead of the Bank of England’s Inflation Report. We expect the monetary policy committee to reiterate its neutral policy outlook and not renew its QE programme. That said, the GBP’s longer-term outlook remains clouded by the UK’s uncertain economic prospects. Our updated GBP forecasts see limited downside vs. USD and EUR, but we expect no meaningful recovery anytime soon.