In this publication: Despite our change in US dollar view and EUR/USD forecasts, we still expect USD/JPY to move higher in the coming months. Sterling to stabilise versus the dollar but to weaken versus the euro from Q4 2017 onwards. Our changes in CHF forecasts reflect change in dollar view and a more resilient CHF versus euro in the near term. Scandinavian FX forecasts unchanged. Near-term downside risk for dollar bloc despite our change in US dollar view170227-Major-FX.pdf (462 KB)
Last week we changed our US dollar view and our forecasts for the dollar against the euro. Although there could be some temporary waves of positive US dollar sentiment, we think that it is unlikely that we will see another strong US dollar rally from here on. In fact, we think that the dollar rally is behind us. This is because the real yield support is fading and politics is uncertain on both sides of the Atlantic. Most of the positive news – in terms of the US economy and upcoming Fed rate hikes – is already reflected in the price and investors are already positioned for dollar strength. Our new Q2 and Q3 2017 EUR/USD forecasts are 1.05 (our previous forecast was 0.95). Once ECB tapering expectations start to build in Q4 2017, we expect EUR/USD to rise towards 1.10 which is our new year-end 2017 forecast (previously: 1.00). For 2018 we continue to expect the US dollar to weaken across the board and to start its downturn. By then the positives for the US economy and the Fed rate hikes will be fully anticipated and central banks in other countries will probably stop easing and move towards a less accommodative monetary policy. Our new year-end 2018 forecast for EUR/USD is 1.20 (previously 1.10). For more, please see FX Watch – Dollar rally behind us. As a result, we have also made adjustments to our other major FX forecasts. Below we explain the changes.
The Japanese yen to weaken versus the US dollar in the near-term
Despite our downward adjustment in the US dollar versus the euro, we expect the US dollar to move higher versus the yen in the coming months. USD/JPY moves one-on-one with developments in the 10y real yield spread (based on inflation expectations). In the coming months we expect the 10y real yield spread to widen in favour of the US dollar because of a modest rise in 10y US Treasury yields and a slightly higher inflation in Japan. Therefore, it is likely that USD/JPY will rally above 115. However, we do not see USD/JPY breaking much above 117.00 and this move will probably be short-lived. Onwards we expect USD/JPY to move lower in line with weakness in the US dollar and the BoJ tapering expectations.
Sterling to stabilise versus US dollar…
We no longer expect sterling to weaken versus the US dollar but for it to consolidate around 1.25. This partly reflects the change in our US dollar view. Moreover, we think that most of the hard Brexit expectations are already reflected in the price. In the period November 2015 to July 2016, sterling had a strong negative relationship with its country default swap or CDS. When the CDS rose, sterling fell versus the euro (see graph below on the left). Despite Brexit, the CDS spread has stabilised and so did the sell-off in sterling. Furthermore, sterling is undervalued especially versus the US dollar. According to purchasing power parity, fair value of GBP/USD is at 1.45 and EUR/GBP is at 0.83. However, we do expect sterling to weaken versus the euro further out. Our new year-end forecast 2017 and 2018 forecasts are 0.88 and 0.89 respectively. Political uncertainty in the eurozone has weighed on the euro versus sterling. If political uncertainty in the eurozone diminishes, this should support the euro. Moreover, financial markets are currently pricing in one rate hike by the BoE in our forecast horizon. We don’t expect the BoE to hike interest rates this year or next year. So if our view is correct, this should weigh on the pound, especially if ECB tapering expectations start to build from Q4 2017 onwards.
…and the SNB to continue to cap the upside in the franc
We have made modest adjustments to our Swiss franc forecasts. The main changes are the result of our change in US dollar view. Moreover, we now think that EUR/CHF will stay close to 1.07 in the coming quarters. The Swiss franc will probably receive support because of eurozone political uncertainty. We expect the Swiss National Bank to cap the rise of the Swiss franc because of low (headline) to negative (core) inflation and because of the high dependency of Swiss GDP growth on net-exports. Therefore, the SNB FX reserves will probably continue to increase. We think that the SNB will continue its foreign exchange interventions as long as CPI will not pick up substantially and net exports remain the main contributor to Swiss economic growth. Once eurozone political uncertainty starts to fade and the euro is supported by ECB tapering expectations from Q4 2017 onwards, we expect the euro to rise also versus the Swiss franc. We expect the Swiss National Bank to lag behind the ECB unless Swiss inflation rises sharply which is unlikely in our view.
Near term upside in the Norwegian krone is limited…
We have not changed our Norwegian krone, Swedish krona and Danish krone forecasts versus the euro. Over recent months, inflation in Norway has fallen dramatically (see graph below on the left) mainly due to food and housing. Meanwhile, 10y Norwegian government bond yields have risen while the 2y yield stayed flat. As a result, Norwegian 10y real yields have risen more substantially than German 10y year real yields proving strong support to the Norwegian krone versus the euro.
Moreover, the rise in oil prices has been another important support for the krone (see graph above on the right). The rise in oil prices has contributed positively to economic growth via the positive contribution of fixed investment to GDP. The Norwegian economy has picked up and its growth has broadened. We think that the Norges central bank has room to hike interest rates twice by 25bp this year. An important condition is that inflation pressures start rising again. Our view of rate hikes is not fully anticipated by financial markets so this should support the krone. However, in the near term we expect lower oil prices which could trigger a profit taking wave in the krone. So we think that the upside in the krone is limited in the near term and we see renewed strength in H2 of 2017.
…while patience is a virtue with the Swedish krona
In the case of Sweden, domestic growth has been strong despite the negative contribution of net exports, but inflationary pressure has diminished. The Riksbank has communicated that it will keep its accommodative policy in place in 2017 and it threatened to intervene in currency markets should a strong krona result in lower inflation. We think that the current monetary policy stance is too accommodative for the Swedish economy, especially for the overheating housing market. We expect that the Riksbank will change its communication in the second half of 2017 resulting in a substantially stronger Swedish krona. We expect a total of 50bp rate hikes in 2018. Overall, we have not changed our Scandinavian FX forecasts versus the euro.
Near-term downside risks for dollar bloc despite our change in US dollar view
We have upgraded our dollar bloc forecasts meaning that they are now less negative. However, this does not mean that we are positive on dollar bloc FX. In fact, we see near-term downside risks which are dampened by our change in US dollar view. For a start, our metals analyst expects a sharp drop in iron ore prices in the coming quarters. This will probably drag down the Australian dollar as well as they tend to move in tandem.
Moreover, we also expect lower oil prices in the coming quarters, which will be a negative for the Canadian dollar. The futures market shows that the net-long speculative positions for Australian dollar and Canadian dollar are sizeable. If iron ore and oil prices start to move lower, these currencies could fall considerably because of position liquidation.
At the end of this year and next, we expect these currencies to rally because of expectations of monetary policy tightening in these countries, while Fed rate hikes will already be reflected in the US dollar. Moreover, we are also more constructive on commodity prices in 2018.