FX Convictions – Euro recovery temporary

by: Georgette Boele , Roy Teo

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We have kept most of our main FX convictions…but have closed our sterling call

Since our latest report on 2 April, we have kept in place our long US dollar views versus the euro, the yen the Australian dollar and the New Zealand dollar. However, we have closed our short sterling call. The surprising election outcome has reduced political risk for now. We have therefore revised our forecasts and to close our sterling short versus the US dollar with a small positive total return. The BoE rate hikes will likely come into focus and this will support sterling in our view.

 

Recent bounce in EUR/USD to be temporary…

Stronger-than-expected eurozone data, weaker-than-expected US data, combined with an improved investor sentiment and higher bond yields gave strong support to the euro. EUR/USD rallied from below 1.06 to around 1.14 or an increase of more than 7%. This rally is temporary in our view. We remain of the view that EUR/USD will move lower. The ECB’s aggressive QE programme will continue to push the euro lower and weigh on eurozone yields again. In addition, stronger US economic data will trigger a 25bp rate hike at the September Fed meeting. Financial markets will adjust to factor in further Fed rate increases this year and next year. We expect this to happen over the coming months. This is a major positive driver for the US dollar. We have adjusted our near-term forecasts to reflect the recent dynamics. We hold on to our view that EUR/USD will move below parity this year. But towards the end of this year, the possibility of ECB exit will already result in a recovery in the euro. Therefore, our new EUR/USD forecast for the end of 2015 is 1.00.

 

…also more yen weakness because of more monetary policy easing ahead…

It is likely that weakness in the Japanese yen also has further to go. This is because USD/JPY is very sensitive to developments in the interest rate spread between the US and the Japanese economies. While US short-term interest rates will move higher, we expect the BoJ to step up its monetary easing programme later this year.

 

Negative on Australian dollar and New Zealand dollar

We expect the Australian dollar and the New Zealand dollar to be pushed down by the dovish stance of the respective central banks. A combination of interest rate cuts and/or intervention to weaken the currencies are likely options. The rebound in the US dollar will be particularly marked against these currencies.