Global FX Strategy: Morgan Stanley

USD: Buying USD Dips. Bullish.

We believe the current USD correction offers an opportunity to enter long USD trades in line with USD bullish view. The current period bears little resemblance to the beginning of last year which led to a lasting peak in USD for many months as the Fed turned more dovish. We still believe in the reflationary theme and expect a hawkish Fed, expectations around fiscal policy and the threat of protectionist measures will keep USD supported. The Fed minutes this week show the Fed is comfortable with the market’s hawkish interpretation of the SEP dots. Crowded positioning remains a risk in the near term in addition to disappointment on the policy front.

EUR: Selling Rallies. Bearish

The development in real yields and ECB policy offer good reasons to be short the EUR. The ECB has developed a dovish framework even as signs of inflation are appearing in the Eurozone. While the EUR  REER trades 22% above its low point reached in 2000, the increasing economic divergence within the Euro bloc and the rising populist risk via upcoming elections in Holland, France and Germany all argue for a weaker EUR. As global inflationary pressures rise and rise and risk appetite stays strong, we would expect the EUR to weaken. We add a short EURUSD limit order to our portfolio this week.

JPY: Buying USDJPY Dips. Bearish.

We like buying the recent dip in USDJPY as our core views have not changed. We continue to expect USDJPYto rise to our 130 target in mid-2018. Reflationary impluses support our structural bullish USDJPY view. US fiscal and monetary policy are leading to higher interest rates in the US. At the same time, the BOJ’s yield curve management ensures that higher global rates push rate differentials against JPY. Crowded positioning, particularly by the fast money community, remains a risk to overview and probably at least partly to blame for USDJPY’s recent fall.

GBP: Tough Times Ahead. Bearish

We reiterate ourview that GBP is likely to weaken to reach its cyclical low in 1Q17. Post-Brexit investment spending weakness should become more evident in the data, following the downside surprise in 3Q16 business investment. Ahead of the government triggering Article 50 by end March, the split position between “hard” and ‘soft’ Brexit will come increasingly into focus. Tensions within the government may also become more visible, particularly if the Supreme Court gives the Parliament additional rights to decide on the exit negotiation strategy.

CHF: Driven By USD. Neutral.

Given our expectation for a USD to outperform other commodity currencies. CAD is not as vulnerable as MXN to trade protectionism given a prior free trade agreement which would take effect if the US backs out of NAFTA, though this remains a risk. However, a better US economic outlook (from other policies like fiscal stimulus) should benefit Canada. The main risk to our call is the weaker data we have seen recently. The BoC’s new core inflation measures show a decline recently and December GDP was weaker than expected. We still don’t expect BoC easing tough, as Poloz noted that it would take a “significant departure” in the outlook for that to happen.

AUD: Market Too Hawkish on RBA. Bearish

We are bearish UD and expect it to underperform NZD. The market has priced too hawkish a path for the RBA despite little improvement in data. 3Q GDP contracting 0.5% and a poor trade report show that despite the better external environment, Australia’s economy is still struggling. Australia remains vulnerable to falling house prices and will also be hurt as China’s mini-cycle recovery slows. While the RBA may not cut rates for the foreseeable future, in overview it will make sure the market reflects its easing bias, weakening AUD. AUD is also particurlarly vulnerable to rising US interest rates given its high yields status (relatively speaking) and current account deficit.

NZD: Outperformance vs AUD. Neutral.

We expect NZD to outperform AUD but weaken against USD. New Zealand’s economic outlook has improved with high migration and booming housing supporting growth. The half-year update this week from Bill English confirmed this, with growth being revised higher and rising budget surpluses. This is likely to be enough to offset the RBNZ worries over the inflation outlook and, in particular, the exchange rate. However, we don’t rule out another rate cute or even FX intervention, though the letter would occur only after substantially more FX appreciation. We expect NZDUSD to continue to depreciate due to our expectation for USD to rise but we expect NZD outperformance of AUD in the near term unless we see worsening data in New Zealand or dovish rhetoric from RBNZ.




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