FX Watch – Changes to our forecasts

by: Georgette Boele

In this publication: We upgraded EUR/USD to 1.20 end 2017 (from 1.15) and 1.30 end 2018 (from 1.20). Sterling to outperform the dollar and to be resilient versus the euro. Higher Canadian dollar, Australian dollar, New Zealand dollar, Swedish krona and Norwegian krone versus the US dollar. We expect upside for euro versus Swiss franc, Japanese yen and Canadian dollar but weakness versus Australian dollar, New Zealand dollar, Swedish krona and Norwegian krone.

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We upgraded EUR/USD

Earlier today we released our FX Watch: Euro strength not over yet (see here). We increased our year-end EUR/USD forecast to 1.20. In the near-term net-long position liquidation will probably push EUR/USD towards 1.15 but later in the year we expect EUR/USD to move back to 1.20. We also increased our 2018 year-end target from 1.20 to 1.30. We expect the ECB’s – albeit slow exit – to support the euro, just as the Fed’s gradual exit from QE supported the dollar in the past. The upside in EUR/USD will likely be dampened somewhat as the Fed reduces its balance sheet and continues to hikes rates at a modest pace. In short our new EUR/USD forecasts reflect more US dollar weakness and more euro strength at the same time. How does this new EUR/USD forecast translate in to our other currency forecasts?

Sterling to outperform the dollar and to be resilient versus the euro

We expect sterling to outperform the US dollar mainly reflecting US dollar weakness. Sterling’s performance versus the euro is less clear cut. Relatively high inflation numbers will keep expectations about a BoE rate hike this year alive even though this is not our base scenario. Moreover, Brexit negotiations will continue to impact sentiment towards sterling and it is difficult to call how the news flow will go in the near term. However, we do ultimately expect to see progress in the negotiations, including the agreement of a transition period, which would be constructive for sterling. Taken all the factors into account we expect a higher sterling versus the US dollar and a resilient sterling versus the euro.

We remain positive on growth- sensitive currencies

We have a strong conviction that the US dollar has entered a multi-year downtrend. This is reflected in our lower US dollar forecasts across the board. We expect investor sentiment to be constructive (with some waves of risk aversion) and this should support currencies of commodity exporters and currencies that thrive if global economic growth and global trade do well, such as the Canadian dollar, Australian dollar, New Zealand dollar and Swedish krona. Moreover, we expect oil prices to rise this year and next year. This should be supportive for oil-sensitive currencies such as the Norwegian krone and Canadian dollar. In addition, we expect central banks in these countries to start tightening monetary policy before the end of 2018. So the Fed is not the only central bank in tightening mode. The Bank of Canada has already started hiking interest rates and expectations about future tightening are about right.

Upside euro versus the Swiss franc, the Japanese yen and the Canadian dollar…

We expect the strengthening of the euro to continue versus the Swiss franc, Japanese yen and the Canadian dollar during our forecast period. First, we expect the ECB’s slow exit to support the euro. Second, the ECB will likely make monetary policy less accommodative before the Swiss National Bank and the Bank of Japan, because of particularly weak inflationary pressures in Switzerland and Japan. Third, we expect investor sentiment to remain constructive and this should weigh on the franc and the yen. Fourth, we expect eurozone political risks to remain low in the coming quarters and this will also weigh on the franc versus the euro. However, in Q2 2016 the Italian elections could increase eurozone political uncertainty and support the Swiss franc versus the euro (but that should be relatively transient). Finally, we hold the same view as the market concerning future rate hikes by the Bank of Canada. Therefore, we think that the euro will outperform the Canadian dollar. In short, expectations about monetary policy and constructive investor sentiment will support the euro versus the Swiss franc, Japanese yen and the Canadian dollar.

…but downside versus Swedish krona, Norwegian krone, Australian dollar and New Zealand dollar

Even though we are positive on the euro, growth sensitive and commodity currencies will likely outperform the euro. For a start, if investor sentiment remains constructive and commodity prices do well, these currencies are better positioned to profit from higher global growth. Second, central banks in these countries will hike interest rates way before the ECB in our view.