Staying EUR Long; Staying USD Offered
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EUR support in the wings, staying long: There will be conclusions to be drawn for other currencies deploying NIR policy such as CHF, SEK or EUR. The short end of these currencies has priced in local central banks either keeping current monetary accommodation in place or cutting rates even further.
The Japanese experience could undermine this expectation, adding another reason why EUR should rally from here. In line with our interest rate strategy team, we see rate and yield differentials becoming more EURUSD-supportive. EURGBP longs remain our best trade.*
Staying USD offered: Increasingly, we differentiate between currencies with ‘exploited’ and still normal, i.e., positively yielding curves. Due to the lack of transmission mechanisms, expansionary monetary policy instruments no longer stimulate economies within an environment of ‘exploited’ yield curves. Here central banks will have to hope for external factors to turn the outlook for the better or they will have to aim for new – more revolutionary – measures. Friday’s outcome of the BoJ meeting suggests that the authorities were not yet ready to step into new, untested territories.
Where yield curves are still normal and positively yielding, central banks are still willing to ease, as illustrated by today’s RBA. However, the now more limited scope of yield curves makes them use the interest rate instrument only reluctantly. This is why the RBA did not provide forward guidance on rates today, limiting the FX- weakening impact. As a result, we do not expect much new information from Friday's Statement of Monetary Policy. In countries where yield curves are ‘exploited’, currencies should rise, driven by rising real yields. Consequently, USD should remain offered.
*Morgan Stanley maintains a long EUR/GBP position in its strategic portfolio and a long EUR/USD as a tactical trade of the week.
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