US dollar favoured as economy improves
The US dollar was the clear outperformer during the past month as the US economy rebounded strongly in the second quarter. Market expectations that the US Federal Reserve may tighten monetary policy somewhat earlier next year also supported the USD. We expect a more significant upward adjustment in market rate expectations to take place later this year given our upbeat view of the economy and labour market. This should lead to further USD strength. Currencies of emerging market economies with an unfavourable macro-economic outlook and/or external and fiscal imbalances are vulnerable to such a shift in US monetary policy expectations.
Our high conviction views broadly unchanged, with the exception of the SEK and AUD
Most of our high conviction views have remained in place. We remain negative on the euro, the Japanese yen and the Swiss franc, while we remain positive on the US dollar generally, Mexican peso (one of the few currencies we expect to strengthen versus the USD) and Polish zloty. At the start of last month, we removed our long conviction view on the Swedish Krona due to a more dovish central bank and weaker than expected economic outlook. We also re-introduced our bearish Australian dollar call. Meanwhile, the euro has come under pressure as speculative short futures positions have been built up on the view that the ECB’s monetary policy will remain accommodative for longer than other central banks. On the other hand, the Chinese yuan has firmed in line with evidence that China’s economy has regained some traction. We judge that the Bank of Japan’s optimistic view that their 2% inflation target will be achieved by the middle of FY 2015 will be challenged in the coming months.