Weekly forecast - page 19
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USD, EUR, GBP, CHF, CAD, AUD, NZD: Weekly Outlook - Morgan Stanley
USD: Lower USD for Now. Bearish.
This week's Fed meeting has done little to change our view that USD is likely to remain weak in the coming months. While the Fed inserted a line about diminished risks, this is more an affirmation of current market pricing and consistent with the view that the Fed wants to provide itself optionality to hike this year. However, we expect inflation and growth data to slow in 2H and ultimately force the market to price out hikes as the Fed chooses to eventually be more cautious. As long as risk appetite remains supported, investors' search for yield continues and market pricing of rate hikes doesn't move much higher, we expect USD to weaken from here.
EUR: Staying Bullish. Bullish.
While any negative results may weigh on EUR, this is likely to be temporary, helped by the ECB's endorsing of a public backstop for NPLs. Therefore, we stay bullish on EUR on the basis of rising real yield differentials and EMU's weak banks and insurance companies not exporting sufficient long-term capital to counteract inflows from the EMU's current account surplus. Our favored way to play this bullish EUR view is through long EURGBP positions.
GBP: BoE Dictates GBP. Bearish.
This week, all eyes will be on the BoE rates decision on Thursday, where we are long EURGBP and like to sell GBPUSD on rallies. Given the marked slowdown in the UK's survey data and the previously hawkish MPC member Weale supporting monetary stimulus, some form of easing seems inevitable. Here, the size of the easing package will be key. Markets have priced in a 25bp rate cut, but our economists are forecasting a 40bp cut with potential for additional QE, suggesting that GBP still has downside potential. The bearish GBP trade won't stop there, supported further by weak survey data translating into weak hard economic data
CHF: Strength Against USD. Bullish.
We think that CHF should stay relatively stable against EUR but appreciate against USD. Switzerland has a 10% of GDP current account surplus, suggesting that commercial buying needs will help the currency to stay supported. At the same time, banks are reducing fresh foreign lending due to balance sheet constraints, reducing CHF outflows. We would promote selling USDCHF to hedge against the long calendar of European political risk events starting in October, as CHF tends to strengthen when the source of risk sell-off originates from within Europe. Furthermore, CHF yields remain very low already so it will be difficult to weaken them through further rate cuts (though the SNB can intervene in times of high volatility to prevent excessive appreciation).
CAD: Turning Neutral. Neutral.
We have turned neutral CAD following the surprisingly hawkish BoC meeting. Despite revising down its growth forecast and pushing back the date of output gap closure, the BoC maintained a neutral tone and showed no willingness to ease any time soon. Based on rhetoric from the press conference, it appears more worried about housing than its forecasts imply, understandable following data released yesterday morning showing a further acceleration of nationwide house prices (mainly due to Vancouver and Toronto). The BoC also emphasized a willingness to look through short-term disappointment on trade data and remained confident that data would eventually rebound. However, by forecasting a strong rebound in 3Q and 4Q growth, the BoC has set itself a high bar: if growth fails to meet these optimistic expectations, easing may come back on the table. For now, we don't like trading CAD from the short side and believe it can appreciate further from here, though positioning remains very long.
AUD: CPI Weak Enough for RBA Cut. Bearish.
This week's 2Q CPI print was slightly better than expectations on underlying inflation measures, but we expect that it is still weak enough to push the RBA to cut rates at next week's meeting. Inflation remains comfortably below the 2-3%Y band and it is unlikely that the RBA's SMP forecasts will be revised much higher in light of this print and with AUD's appreciation in recent months. With the market closer to 50/50 now for a cut, risk/reward for short AUD positions has improved. Even without a rate cut, our long-term bearish view remains and we expect the turning housing cycle to weigh on domestic demand growth over the next year, weakening AUD.
NZD: Near-Term Weakness. Neutral.
The weak CPI and high TWI have pushed the RBNZ to release an economic update foretelling easing at the August meeting. For now, we believe that NZD can weaken ahead of the meeting if markets price a more aggressive easing path. However, we are skeptical about the RBNZ's willingness to follow through on substantially more easing than market pricing, and housing remains a concern despite upcoming macro-prudential regulations. We await more clarity from the August MPS and expect that NZD could then outperform if the global search for yield continues.
EUR, JPY, GBP, CHF, AUD, NZD: Weekly Outlook - Morgan Stanley
EUR: Supported by USD Weakness. Bullish.
EUR has appreciated in the past week on the back of broad USD weakness, which we expect will continue. While US real yields are declining, EUR real yields are rising. Despite the recent rally in bond yields, German 10y bonds are still negatively yielding, reducing the elasticity of nominal yields to the downside. This results in EUR real yields rising as global inflation expectations fall faster than nominal yields. Given the ongoing debate about the effectiveness of central banks' negative interest rate policy, EUR nominal yields could also continue to push real yields up in support of EUR. Our favored way to express this bullish EUR view is through long EURGBP positions.*
JPY: Staying Bullish. Bullish.
In the past week, the Japanese authorities announced an expansion of their fiscal and monetary easing measures, but we doubt an increase in the size of these conventional measures will be effective in boosting local inflation expectations. 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. Our analysis also shows that Japanese investors get the highest returns by FX-hedging purchases of US 10y bonds, which could drive an increase in hedging of existing holdings, pushing USDJPY lower. We expect USDJPY to test the next chart levels of 100.20 and 99.05, targeting our forecast of 97 for the third quarter.
GBP: Front-loaded GBP Weakness. Bearish.
The BoE delivered Thursday with a comprehensive easing package including a 25bp cut, additional QE, corporate bond purchases and the Term Funding Scheme. Possibly more important than the package itself is the fact that most MPC members are expecting, not just willing, to cut rates further based on their forecasts. This aggressive approach is likely to cause more GBP weakness and support our 3Q target of 1.24 for GBPUSD. The BoE appears welcoming of further GBP depreciation despite the likelihood that FX pass-through pushes inflation above target. Should we see a large fiscal response or growth doesn't deteriorate as much as expected, we may then reconsider our bearish near-term GBP view.
CHF: Real Yield Support. Bullish.
In the past week, CHF has strengthened as investors price out the probability of the SNB cutting rates further into negative territory. Should the rally in bond yields continue, this would lift real yields in support of CHF. With CHF's sovereign yield curve almost entirely in negative territory, the downside for nominal yields is also limited, which brings real yields up as global inflation expectations fall faster. Given our expectations for further USD weakness, we like selling USDCHF to hedge against the long list of European political risk events starting from September, as CHF tends to strengthen when the source of risk sell-off originates from within Europe.
AUD: Bullish Following Rate Cut. Bullish.
We have turned bullish AUD in the near term and believe it can continue to rally following the RBA's rate cut. AUD's reaction to the rate cut is telling, given it ended the day over 1% higher against USD despite the rate cut not being fully priced in. As the hunt for yield remains strong and the RBA's lack of an easing bias indicates no easing catalyst any time soon, we expect AUD to appreciate (particularly against USD). Our long-term bearish view remains, but 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. Neutral.
The weak CPI and high TWI have pushed the RBNZ to release an economic update foretelling easing at the August meeting. However, with a full rate cut priced in and the market's continued hunt for yield (see AUD), we don't expect NZD to weaken much even if there is a rate cut. We are also skeptical about the RBNZ's willingness to follow through on substantially more easing than market pricing, and housing remains a concern despite upcoming macro-prudential regulations. We await more clarity from the August MPS and expect that NZD could then outperform if the global search for yield continues.
USD: Still Bearish USD. Bearish.
We believe USD positions will continue to unwind as weak US data put Fed rate hikes in doubt and the search for yield continues. US data remained poor this week with productivity numbers pointing to increasingly low potential growth for the economy. While some have argued this would make the case for earlier rate hikes, we believe this data will push the Fed to be more cautious in light of little inflationary pressures in the economy. We expect inflation and growth data to remain weak in 2H, ultimately forcing the market to price out hikes. As long as risk appetite remains supported, investors' search for yield continues and market pricing of rate hikes doesn't move much higher, we expect USD to weaken from here.
EUR: Expect More Strength. Bullish.
We expect EUR to stay supported. The results from a German ZEW study showed that EU banks have larger capital shortfalls than that indicated by the official EBA stress test, supporting our argument that EMU's financial institutions are unable to export long-term capital due to their weak balance sheets. This results in the commercial demand for EUR from the EMU's rising current account surplus dominating, helping the EUR stay supported. EURUSD has been relatively stable in the past week despite USD weakness, and we expect the pair to catch up with USD weakness. As such, we like buying EUR against USD and particularly against GBP.
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, approaching 0), but we don't expect an offsetting increase in unhedged flows. We expect USDJPY to test the next chart levels of 100.20 and 99.05, targeting our forecast of 97 for the third quarter.
GBP: Front-loaded Weakness. Bearish.
GBP has broken below 1.30 for the first time since Brexit after the BoE’s McCafferty – one of the more hawkish members on the MPC – called for more monetary easing if the economy worsens. With our economists’ view that the BoE’s forecasts are too optimistic, this dovish stance supports their expectations of a second easing package in November. Our economists are calling for another 15bp cut, which is larger than market's current pricing of 10bp, suggesting there is room for further GBP weakness. GBP real rates and yields have also fallen to negative levels, making it unattractive in the current yield-seeking environment. We remain GBP-bearish and like selling against EUR and USD which we hold in our portfolio.*
CHF: Strength Against USD. Neutral.
We expect CHF to strengthen against USD. A large part of Switzerland's sovereign yield curve is in negative territory, limiting the room for nominal yields to fall further. With inflation still in negative territory, inflation expectations may fall faster than nominal yields, pushing CHF's real yields up to support the currency. On the other hand, we expect US real yields to decline, hence real yield differentials should push USDCHF down. We expect stability in EURCHF as EUR's real yields are also rising, and the upside in the pair may be capped by potential intervention from the SNB.
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Week Ahead USD And Fed Hikes: The Timing Vs The Grand Total
We break down the USD response function to Fed tightening into two components. The first is the expected total number of hikes in the coming years, approximated by the slope of the short-end of the US yield curve. The second is the expected timing of the next rate hike, approximated by short-term rate expectations. Our econometric analysis suggests that the steepening of the US yield curve has been the main support for the USD rally prior to Brexit. It has lost significance ever since, however, as investors pared back their long-term rate hike expectations and the curve flattened.
Short-term rate expectations have been generally supportive for USD since the December lift-off and we think that constructive Fed rhetoric and a rate hike in the coming months should continue to help the currency. Our analysis suggests, however, that the impact may not last unless we see a renewed sustained steepening of the US yield curve.
While the latest US curve flattening is starting to look aggressive by historic standards, there are reasons to believe that investors will remain cautious when frontloading Fed rate hikes once again. Indeed, recent Fed comments about the declining natural rate in the US and abroad are hardly calling for a major rethink of the dovish long-term market rate expectations.
Over the longer-term, a shallower and slower Fed tightening cycle could support demand for yield. That said, lingering uncertainty about global growth and inflation should act as a counterweight, keeping the outlook for the G10 commodity currencies less rosy. The limited scope for further easing by the ECB and the BoJ could also point towards some resilience of the EUR and JPY against the USD.
In terms of FX vol space, spot volatility and key market events remain drivers for FX implied vols. However, we expect spot moves to be more important for front-end vols while for longer-dated vols interest rate volatility should have a greater influence. A slower pace of Fed hikes coupled with limited scope for further easing by other central banks suggests a lower prospect of volatility in future interest rates, which could weigh on longer-dated vols.
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How to trade the majors this week - Morgan Stanley
What to watch for this week in the euro, yen, pound and more
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. 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.
USD: Limited USD Rally. Neutral.
We maintain our view that the USD will remain weak against EUR, CHF and EM. While recent Fed commentary has continued to be hawkish, US data has been coming in weak, with the latest non-manufacturing ISM figure falling to the lowest level since 2010. Therefore, we continue to think that even if the Fed hikes - which is not our base case - it will be a 'dovish' hike followed by a long pause and the neutral real rate will stay depressed, keeping risk supported and long-term yields low. Given our view that G4 long-end rates, which matter more for EM, will stay low, and the EM-DM growth differential widening over recent quarters, EM inflows will likely stay strong as the hunt for yield continues.
EUR: Buy EUR Crosses. Bullish.
EUR remains our favourite currency to buy. The latest ECB meeting did not deliver QE extension as expected by most market participants and provided no guidance on the Bank's policy stance after March 2017, helping EUR to rally. While our economists expect the ECB to ease in December, the low-rate and flat-yield-curve environment in EMU prohibits further easing from translating into a weaker EUR. The flat yield curve also hurts EMU banks' profitability, reducing their willingness to take foreign FX risk onto their balance sheets, resulting in the lack of longterm capital exports to offset the inflows from the EMU's current account surplus. We like focusing on buying EUR crosses such as EURJPY, EURAUD and EURCAD.*
JPY: Room for Sell-Off. Neutral.
We have turned more cautious on JPY and see room for USDJPY to rally to 107/108 on the back of market expectations for the BoJ introducing innovative policies at its September meeting. The BoJ has shown signs of changing its approach by reducing long-term bond purchases, helping the JGB curve to steepen. A steeperyield curve helps improve banks' profitability, increasing their ability to take more foreign FX risk onto their balance sheets by buying foreign assets, generating outflows to weaken the JPY. However, we ultimately expect the JPY weakness to reverse if the BoJ sticks to its existing monetary toolbox at the September meeting.
GBP: Data-Heavy Week. Neutral.
We expect the GBP rally could continue, with GBPUSD and GBPJPY potentially reaching 1.35 and 145 respectively. Recent UK data has been surprising on the upside, reducing market fears of a Brexit-related growth slowdown. Our economists now expect UK growth to show an expansion instead of contraction in 3Q. If - as initial data suggests - the weaker GBP has started working its effect on boosting the economy, the data points this week could continue to surprise on the upside, helping GBP to rally. CFTC data shows GBP short positioning is near the historical high, thus a continued rebound in UK data and markets' pricing out of BoE easing could be met by swift appreciation of GBP.
CAD: Bearish Supported by BoC. Bearish.
We remain bearish on CAD, with the latest change in the BoC's stance adding support to ourview. In its latest 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. This increases the possibility of the BoC cutting rates this year, especially since we are skeptical that exports can rebound enough in the second half of the year for the BoC to hit its forecasts. Given the markets are only pricing in 2bp rate cut for this year, and CAD has the largest long positioning in G10, we think further data weakness could weaken CAD significantly.
AUD: Upside but Cautious. Neutral.
We think AUD may have some more room to rally as the bid foryield continues but we are cautious on the sustainability. First, iron ore prices have started to turn around, which doesn't help the currency. Second, the weak RMB is likely to add to the deflationary pressures within Australia. The RBA kept a neutral tone this week but we think they will have to cut in coming quarters due to the lack of inflation in the country. We prefer to trade AUD crosses so are still long EURAUD and see downside for AUDNZD. Australia's 2Q GDP did not contract but was largely supported by fiscal spending, suggesting there is a risk the growth is not sustainable.
NZD: Increased Migration Supports Consumption. Bullish.
There are many reasons to be bullish on the NZD. The first one is technical, as the NZD is the highest beta currency in G10 so when the USD weakens, the NZD strengthens. Fundamentally, dairy prices continue to rise, the housing markets remains supported and consumption data is coming in strong. The prime minister this week made comments suggesting the country is encouraging more migration which should continue to help with the housing market and construction industry. Inflation remains low, but even if the RBNZ cuts rates, it is difficult for the central bank to weaken the currency in a time when markets are looking for anything high yield. Foreign participation in the New Zealand bond market declined last quarter so there is room for a pickup, driving up the currency, if nearby Asian yields remain low.
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Quant Signals: Short GBP/USD, Long EUR/GBP, Short EUR/SEK
SNB Sep Meeting: Thurs Sep 15 - 3:30 AM ET.
Morgan Stanley: Bullish CHF On SNB Inaction; A Buy On Crosses.
We remain bullish on CHF and like buying crosses such as against CAD, AUD and JPY. This week, the SNB rates decision will be the main idiosyncratic risk event. Markets are pricing for a dovish SNB and a further 4bp rate cut by December, but we do not expect the SNB to change its policy. This gives potential for CHF to rally as markets get disappointed and adjust their rate expectations. Coupled with rising real yields, Switzerland's 10% of GDP current account surplus, and weak banks' balance sheets reducing the export of long-term capital, we think CHF has more room to the upside
Credit Agricole: SNB On Hold; CHF Remain The Most Overvalued G10 Currency.
CHF remains the most overvalued G10 currency and we expect it to underperform from here. For now the currency remains mainly driven by global risk sentiment. This is unlikely to change unless there is rising scope of the SNB considering additional policy action. Regardless of still muted price developments, it appears unlikely that the central bank will consider additional policy steps as soon as this week. This is especially true as global conditions have been pretty stable owing to, among others, less adverse contagion from the Brexit vote than initially feared. Nevertheless, as the overvalued currency is keeping monetary conditions too tight and as forward looking indicators such as the KOF leading one paint a more lacklustre picture, there is no scope of them considering a less dovish stance neither. If anything the central bank should stick to a policy mix consisting of negative interest rates and currency intervention and such prospects should keep the franc’s safe haven appeal relatively low. Still, risk sentiment will stay an important driver. As a result to the above outlined conditions we expect crosses such as EUR/CHF to remain well supported.
Barclays: No Change From The SNB; EUR/CHF Neutral.
We expect the SNB to keep its policy settings unchanged at its September meeting (Thursday) including its policy rate at -0.75%, the target range for the three-month Libor at -1.25/-0.25% and the exemption from negative deposit rates it gives on the majority of domestic banks’ reserves. Subdued market volatility since Brexit, has implied a c.1.6% CHF REER depreciation, which in addition to a modest improvement in Swiss data, should keep the SNB comfortably on hold, in our view. Reduced pressure for the SNB to act can also be implied by the decline in our estimates of FX intervention since June (Figure 5). We expect the policy announcement to be neutral for EURCHF.
BoE Sep Meeting: Thurs Sep 15 - 7:00 AM ET.
Credit Suisse: BoE To Tweak Dovish Tone; GBP/USD A Buy.
We expect BoE to marginally tweak down its dovish tone this week, which should give a brief lift to the pound.We see little incentive for the MPC to be any more dovish than the market is already pricing in for the remainder of the year (around 7bp of cuts). In fact, at this point the BoE may now even want to avoid raising the market's expectations for additional easing, given some of the glitches it has had with QE bond shortages and the uncertainty of whether it needs to save ammunition for a 'hard-Brexit'. The MPC may take advantage of the stretch of recent data to paint a more balanced 'wait-and-see' message - perhaps by sounding encouraged by the pass-through of the recent rate cut or more concerned about the upside inflation risks. While FX markets do not seem to be pricing in a particularly eventful or dovish MPC meeting, positioning remains highly short in GBP, and the pound has not hesitated to rally in response to local data and MPC guidance.
Credit Agricole: Limited Scope For A Surprise; Limited GBP Upside From Here.
When it comes to the BoE, we see limited scope for a surprise. If anything, the central bank should leave all options open when it comes to the need for further policy measures, as overall uncertainty – for instance, related to next year’s Brexit negotiations – should persist. Such an outcome would be fully in line with last week’s testimony in front of parliament. If anything, one should therefore expect central bank rate expectations to remain strongly capped and such prospects are likely to prevent the currency from facing more sustainable upside from the current levels. This is especially true as speculative short positioning may be less elevated as for instance suggested by IMM data alone.
Barclays: BoE On Hold On Thurs; GBP/USD En-Route To 1.27 By Year-End.
This week’s BoE meeting (Thursday) will be the key event risk for GBP and we expect no change in the MPC’s monetary policy settings. We look for unanimous voting in favour of the status quo for the current APF (9-0) but do believe that dovish Committee member Gertjan Vlieghe is likely to dissent and vote for a cut (8-1). Moreover, we expect the minutes to echo the testimony of Governor Mark Carney and Committee members Jon Cunliffe, Kristin Forbes, and Gertjan Vlieghe to the Treasury Select Committee and think the MPC is comfortable with its recently announced easing package. A confirmation of this and openness towards further easing, should downside risks to the economy materialize, will likely keep GBPUSD under pressure, in our view. Barclays targets GBP/USD at 1.27 by the end of the year.
USD Rally To Fizzle Out; The Transition To JPY Bearishness - Morgan Stanley
USD Rally To Fizzle Out; The Transition To JPY Bearishness - Morgan Stanley
USD rally to fizzle out. The USD has rallied over the past three weeks, but US economic indicators have undershot market expectations for nine weeks. Our US economics team projects the US economy to slow down from its current 3.1% expansion in 3Q to 1.5% in 4Q. August retail sales data have disappointed, and with the US election campaign now heating up, uncertainties may keep the economy on the back foot. A USD rally may need risk to sell off further from here
The transition to JPY bearishness. Steepening the JPY yield curve is a necessary, but not sufficient condition to weaken the JPY. Specifically, the steeper curve also requires higher inflation expectations. Here, fiscal authorities have to step up, not necessarily by launching another spending package, but by moving toward long-term funding. Aggressive steps toward long-term funding may help Japan fiscal multipliers to recover by breaking the link between rising sovereign debt and precautionary private sector savings. The BoJ's yield curve operation has put the ball in the MOF's court. Should the MOF decide to play, the JPY may develop surprising weakness.
Trading FX if curve steepens with higher inflation expectations. The first and most important implication of a steeper yield curve driven by higher inflation expectations is that we think the JPY would weaken. Markets have done a full 180 from where they were late last year. Back then, market participants hoped the JPY weakening trend that had lasted three years would continue. However, matters changed when Japan's yield curve became flatter, with long-term bond yields falling into negative territory. The signal to markets was clear: from here, relative real yields can only fall should Japan be able to boost inflation. The JPY trade became tightly connected to Japan's inflation outlook, creating a negative feedback loop with falling inflation feeding into a stronger JPY and the stronger JPY dampening import prices leading toward an even stronger JPY. It is about breaking the loop. Should Japan's authorities recognise these challenges, then it would be time for us to lean against the consensus once again.
In line with this view, Morgan Stanley maintains a long EUR/JPY position targeting a move to 120 with a stop at 112.30.
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Morgan Stanley's USD, EUR, JPY, GBP, CAD, AUD, NZD weekly outlook
USD: Fed to Weaken USD. Neutral.
We think a dovish Fed and a benign external environment over the next few months will help weaken USD. 3Q growth has bounced back but US data has been worse than expected, including today's retail sales print, setting up for a weak 4Q quarter as the Fed contemplates additional rate hikes. We also think that even if the Fed hikes - which is not our base case - it will be a 'dovish' hike followed by a long pause and the neutral real rate will stay depressed, keeping risk supported and long-term yields low. A risk-off environment is certainly a risk but we don't expect higher yields and steeper curves to cause the months long risk rally to be derailed. Therefore, EM should continue to perform well against USD.
EUR: Staying Bullish. Bullish.
We remain bullish on EUR and are adding a long EURUSD position today to express a bearish USD view into the Fed. EMU's financial institutions have weak balance sheets and their profitability has reduced due to low yields and flat yield curves. This reduces their willingness and ability to add risk onto their balance sheets, prompting them to reduce their foreign FX-denominated holdings. This results in the lack of long-term capital exports to offset the commercial demand from the EMU's 3% of GDP current account surplus, supporting the EUR. We promote buying EUR against USD, GBP and JPY.*
JPY: Room for Sell-Off. Neutral.
We think JPY has room to weaken should the BoJ credibly raise inflation expectations at the upcoming meeting. The BoJ has shown signs of changing its approach by reducing long-term bond purchases, helping the JGB curve to steepen. A steeper yield curve helps improve banks' profitability, increasing their ability to take more foreign FX risk onto their balance sheets by buying foreign assets, generating outflows to weaken the JPY. However, we ultimately expect the JPY weakness to reverse if the BoJ sticks to its existing monetary toolbox at the September meeting.
GBP: Turning Cautious. Bearish.
While post-Brexit UK economic data has held up better than expected, we are turning more cautious on GBP. In the latest minutes, the BoE reiterated that it will continue to ease if inflation and growth come in line with their August forecasts. However, markets are only pricing in a 7bp rate cut for this year, giving room for GBP to weaken if data starts surprising to the downside and BoE rate expectations are repriced. In addition, even though recent economic data has held up well, we still expect Brexit to drive a growth slowdown which will play out over a longer time horizon. The government's negotiation position regarding Brexit also remains unclear, with risks titled towards a hard exit that significantly reduces the UK's access to the EU market.
CAD: Bearish Supported by BoC. Bearish.
We remain bearish on CAD, with the latest change in the BoC's stance adding support to our view. In its latest 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. This increases the possibility of the BoC cutting rates this year, especially since we are skeptical that exports can rebound enough in the second half of the year for the BoC to hit its forecasts. Given the markets are only pricing in 4bps of rate cuts for this year, and CAD has the largest long positioning in G10, we think further data weakness could weaken CAD significantly.
AUD: Further Upside. Neutral.
We think AUD has further room to appreciate against USD if risk remains supported as decent data is enough to keep the RBA on hold and investors seeking higher yielding assets. Gov. RBA assistant gov. Kent struck an upbeat tone this week and better than expected GDP growth (though with a mixed breakdown) as well as a falling UE rate are good enough to limit the risks of RBA rate cuts, despite a still worrisome inflation outlook. With AUDUSD at 0.75, it still has room to go higher before the RBA becomes too worried about overvaluation.
NZD: Economy Remains Strong. Bullish.
There are many reasons to be bullish on the NZD. The first one is technical, as the NZD is the highest beta currency in G10 so when the USD weakens, the NZD strengthens. Fundamentally, dairy prices continue to rise, the housing markets remains supported and consumption data is coming in strong. This week's 2Q GDP print shows the economy is accelerating again. Inflation remains low, but even if the RBNZ cuts rates, it is difficult for the central bank to weaken the currency in a time when markets are looking for anything high yield. However, NZD remains vulnerable to a risk-off period and from aggressive OCR cuts in response to a too high TWI.