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We continue to expect US dollar strength
Since our latest report on 19 May, we have kept in place our long conviction US dollar views versus the euro, the yen the Australian dollar and the New Zealand dollar. The weakness in the US economy is behind us in our view and economic data will strengthen in the months ahead. This will not only increase investor confidence in the US and the US dollar, it will also trigger a Fed rate hike in September. Currently, money market futures have not even fully priced in one rate hike. We expect two rate hikes this year. This and the upward adjustment interest rate expectations for 2016 should give a strong boost to the US dollar this year. However, this scenario should play out against the background of positive investor sentiment. If investor sentiment were to deteriorate, it is unlikely that the US dollar will profit unless there is market panic. We expect constructive investor sentiment and certainly not market panic.
Still strong conviction in a lower EUR/USD
The recent surprising resilience in EUR/USD in the face of the Greek crisis has challenged our conviction of a lower EUR/USD this year. We expect investors to re-focus on monetary policy divergence. Indeed, with the strengthening of the US economy ahead, the spread in government bond yields will widen in favour of the US dollar. Furthermore, the ECB’s aggressive monetary policy easing will weigh on the euro. Given the divergence, it is likely that EUR/USD will test parity between the third and the fourth quarter.
…remain bearish in yen despite delay in BoJ increasing monetary stimulus…
We now expect the BoJ to increase monetary stimulus only in early 2016 (from July 2015). However our bearish view on the yen remains as we expect interest rate differentials between the US and Japan to widen further. In addition, outward investments from Japan have accelerated by more than expected with a lower currency hedge ratio.
Dovish central banks to weigh on Australian dollar and New Zealand dollar
We expect both the Reserve Bank of Australia and Reserve Bank of New Zealand to lower the Official Cash Rate by 25bp in the third quarter. Weak commodity export prices will also dampen sentiment in both currencies. In addition, the rebound in the US dollar will also push down these currencies.