"The political sky is clearing over Europe with French elections strengthening the pro-European forces and similar indications in local elections in Italy," said CIO Strategist Thomas Flury.
CIO said the European Central Bank's (ECB) communication at the June meeting helped make the decision to lift CIO's three- and six-month forecast. CIO believes the path is cleared for an announcement to taper the asset purchase program in September.
"With all this happening, we assume the path of normalization in foreign exchange is intact and the Euro is about to gain back some of the ground it has lost when the ECB announced its quantitative easing program in January 2015," said Flury.
The euro will also be supported by strong economic fundamentals in Europe. Real growth indicators like business climate, consumer sentiment, export volumes, and unemployment rates are at or close to their best levels since the global financial crisis.
Meanwhile, the greenback remains overvalued and CIO believes that as other countries catch up with the US, the dollar will systematically lose some of its overvaluation, even in a period of Fed rate hikes.
The Federal Reserve hiked interest rates by 25 basis points this week, signaling that it is on course for a continuation of the rate hike cycle with up to three hikes a year. However, there could be volatility in the months ahead as September looks to be a difficult period given that the Trump administration would have to lift the debt ceiling and push a FY2018 budget through Congress.
"The Fed stayed the course this week and left the door open to stay adaptive, if necessary," said Flury.
CIO also lowered its USDCHF forecast slightly to 0.96 from 0.98 in three months and to 0.98 from 0.99 in six months, while keeping the 12-month forecast at 0.97 in line with a change in EURUSD. CIO said in the coming quarters, it expects the Swiss franc to be caught between the euro and the greenback, rising partially with a stronger euro, versus the dollar, but not keeping up with the rise in the euro.
"The trade relationship with Europe is the most important one for Switzerland and the SNB must have a closer look at the developments at the ECB than at the Fed. Nevertheless, USD and CHF are both heavily overvalued versus the euro and therefore they should both weaken when the ECB moves away from quantitative easing," said Flury.
Meanwhile a hawkish turn for the Bank of Canada has opened the way for further Canadian dollar strength down the road. CIO had expected a stronger Canadian dollar but did not expect it to unfold that quickly.
CIO updated its USDCAD forecasts to 1.30 from 1.35 for three months, to 1.28 from 1.32 for six months and to 1.25 from 1.28 for twelve months.
(By UBS)
