FX Convictions – An even stronger dollar

by: Georgette Boele , Roy Teo

140930-FX-Convictions.pdf ()

New forecasts

We have revised our FX forecasts to reflect a stronger US dollar, a weaker euro and a weaker Japanese yen (please see our Global Daily Insight published earlier today). Interest rate markets have so far been reluctant to fully price in the rate path that is being signalled by the Fed. We expect even slightly higher rates than the Fed is currently projecting. If markets start to catch up to the likely extent of rate rises next year, the US dollar is expected to appreciate further. Given this, we have raised our US dollar forecast across the board. In addition, we remain negative on the euro despite the recent fall. This trend is also supported by the ECB. It has finally started to react to weak economic growth and low inflation and has started to ease monetary policy further. In short, the ECB will do all that it can to fuel the slide in the euro. Our new forecasts for EUR/USD are as follow: 1.25 for year-end 2014 and 1.15 year-end 2015 (compared to 1.28 and 1.20, respectively). Moreover, it is likely that weakness in Japanese yen has further to go. This is because USD/JPY is very sensitive to developments in the interest rate spread between the economies. We not only expect the Fed to hike more than currently is anticipated by financial markets and signalled by the Fed. We also expect the BoJ to step up its monetary easing program later this year, something that is not widely anticipated by investors. Therefore, the rally in USD/JPY will continue. Our new forecasts are 115 year-end 2014 (before 110) and 125 year-end 2015 (previously: 120).

Our high conviction views

We keep in place our long US dollar call versus the euro, the yen, the Swiss franc and the Australian dollar. Furthermore, we are also confident that the Chinese yuan will outperform the Japanese yen. However, we have started to doubt that the Mexican peso will strongly outperform the US dollar for the remainder of this year and next year driven by improving fundamentals and capital inflows. It is likely that very few currencies are able to swim against the tide of US dollar strength. Therefore, we have shifted our long Mexican peso versus the US dollar to a long Mexican peso versus the euro. So we have closed short USD/MXN with a total negative return of 1.8% and opened a short EUR/MXN position at 17.00.

20140930 - FX convictions