USD: Further Gains Expected. Bullish.
We increasingly believe the USD is moving back to its long-term bullish trend, driven by two factors. First, the closing US output gap and its implications on monetary policy should move rate and yield differentials in favour of the USD. Second, should global yield curves continue steepening as inflation picks up,volatility could rise and risk appetite could get hit, resulting in USD-supportive repatriation flows. We expect USD strength to be most pronounced against low-yielding currencies (low-yielding AxJ, JPY and SEK) while high yield EM currencies with good fundamental stories may stay relatively resilient.
EUR: Stay Strong on the Crosses: Neutral.
The latest ECB meeting did not reveal any new information and put all attention on the December meeting instead. EURUSD break below the Jun low of 1.0913 could open downside to the February/March low of around 1.0820. On the crosses, however, EUR is likely to remain supported. Should global and EMU inflation continue rising, ECB tapering talk could come back into focus and the current rate cut priced by the markets may be reduced, supporting the currency. In this scenario, global yield curves may also continue steepening, which could hit risk appetite, providing further support for EUR crosses.
JPY: Use USDJPY Dips to Buy*. Bearish.
We expect further USDJPY strength and view the current setback as a buying opportunity. With the BoJ’s yield curve management and steepening of global yield curves, financial institutions’ profitability may improve over time, increasing their willingness to lend domestically and abroad which will weaken the JPY. Market consensus remains bullish JPY with long positioning reaching extreme levels. Should sentiment start to shift, an unwind of these positions could generate a significant reversal in USDJPY to the upside. Additionally, given the increasing hedging costs, Japanese investors may now invest abroad on an FX-unhedged basis, further weakening the JPY.
GBP: Corrective Rebound. Neutral.
We changed our forecasts to expect more GBP weakness in coming quarters and little recovery next year. However, we expect some short-term rebound due to the market’s large short positioning and signs of the government rethinking its hard stance on Brexit, including allowing Parliament to vote on Brexit negotiations. We think the improvement in the news flow gives GBPUSD upside potential to 1.2650, where we would sell again as investment weakness and political uncertainty are likely to weigh on GBP in the medium term. This week, we watch GDP but note that any positive surprise will provide short-lived support for the currency as GBP is predominantly driven by politics currently.
CAD: Turning Neutral. Neutral.
In the latest meeting, the BoC revised their inflation and growth forecasts down and changed their wording on inflation risks to be “roughly balanced”, which was less dovish than markets expected. However, Governor Poloz later said that the bank actively discussed the possibility of adding more stimulus, though it would require a shock or series of shocks for them to ease further. We think this means the Bank is willing to act if the economy takes another dip, but would need shocks such as a significant drop in oil, severe slowdown in the US economy or a US presidential outcome that could change NAFTA for them to deliver more easing. These scenarios look unlikely for now, therefore we turn neutral on CAD.
AUD: DataWatching. Bearish.
AUDUSD has reversed after reaching the upper end of its trading channel following the weak September labor market report, giving it some more room for correction. With mining investment staying weak and the housing market set to slow down, the RBA may need to cut rates further to stimulate the economy. A further steepening of global yield curves and increased pricing of Fed hike probabilities could also hit risk appetite, pushing AUDUSD lower. This week, all eyes will be on CPI and new home sales. Should CPI follow the global trend in inflation and print stronger than expected, AUD could receive a boost but we would use the rally to sell. Accordingly, we add a limit order to sell AUDUSD in our portfolio.*
NZD: Tactical Short*. Bearish.
NZD has the largest potential for correction within G10 in an environment of USD strength and steepening yield curves, in ourview. The RBNZ changed its most recent statement very little despite improving growth data and milk prices and also pointed to slowing house price appreciation. Nonetheless, we believe only an aggressive easing cycle will push NZD substantially lower and we won’t get more clarity on this until the November MPS. Inflation remains low, but even if the RBNZ does small amounts of easing, it is difficult for the central bank to weaken the currency in a time when markets are looking for anything high yield. What can push NZD lower for now is a fall in risk appetite or Fed rate hikes.