Global FX Strategy from Morgan Stanley, this via eFX
USD: Election Results Support USD. Bullish.
The election results reinforce our structural USD bullish view. Three major policy initiatives (fiscal stimulus, trade, corporate tax reform) are likely to be USD positive and the markets focus on reflation should push USD higher against the low yielders, namely USDJPY. We expect the Fed to remain on track and we may finally see a more balanced mix of monetary and fiscal policy, lessening the need for more easing. Little has changed in the last week to impact our fundamental view around USD, though we are closely watching the Trump transition for indications on actual policy implementation next year. Certainly though, there is scope for the USD move to lose steam in the next few weeks but we maintain our medium term view.
EUR: EURUSD Driven by the USD. Neutral.
EURUSD is largely driven by the USD side, meaning that the pair could move reluctantly lower, seeing 1.04 by year end. However, we think EUR should remain strong on the crosses as Eurozone banks are not increasing foreign lending enough to compensate for the current account surplus, and the higher global inflation environment reduces the need for the ECB to add to QE purchases forever. Eurozone political events are now treated as binary risks for the EUR. We believe the main one to focus on is the French election. This weekend we will be watching for the results of the Republican party primary.
JPY: Bullish USDJPY. Bearish.
CPI Reflationary impulses support our structural bullish USDJPY view. Fiscal stimulus-led yield curve steepening and positive risk appetite make long USDJPY one of our favorite trades. The BoJ's yield curve management should ensure that global yield curve steepening pushes rate differentials against JPY. The BoJ's first fixed-rate bondpurchase operation overnight supports this view as it shows they are willing to defend theiryield curve targets rather strictly in light of global curve steepening pressures. In addition, JPY long positioning has further to unwind. Lastly, a global fiscal stimulus impulse may push the MoF to take part which, with long term yields pinned, could provide a substantial boost to Abenomics and weaken JPY further.
GBP: Outlook Stabilised for Now. Neutral.
GBP has become pretty sensitive to bond curve steepness, explaining why it has outperformed in the broad USD rally. The market is still short GBP so position adjustment and no new negative news from the Brexit negotiations should continue to allow GBP to rebound. We have a tactical target of 1.29 for GBPUSD. We are still long GBPJPY*. Market focus in the coming week will be on the release of the UK government's autumn statement. Not much fiscal expansion is expected but any surprise rise in gilt issuance could push up yields faster than in the US, supporting GBPUSD for now. We are still looking for a rebound to sell into 1Q17.
CAD: Vulnerable to Trade But Supported by US Growth. Neutral.
Trump's desire to renegotiate NAFTA has put CAD back into focus. CAD is not nearly as vulnerable as MXN given a prior free trade agreement which would take effect if the US backs out of NAFTA (though Trump could also choose to back out of this agreement too). However, we think this issue has the ability to turn CAD into an underperformer in the commodity complex as trade uncertainty at the very least will add to additional risks to the export sector which has been underperforming. Still, the bar for easing from the BoC is high; the latest BoC meeting showed the Bank revising down their outlook but still keeping rates on hold and actually changing their rate bias to neutral (from dovish). Furthermore, other policies, such as US fiscal stimulus, should positively impact Canadian growth. Thus, we must watch for the actual implementation of trade policy as well as upcoming data but we see USDCAD rising from our broad USD view.
AUD: Structurally Bearish. Bearish.
We remain structurally bearish AUD but see competing factors driving its outlook in the near-term. AUD has been vulnerable to rising US yields and a stronger USD but has been supported by positive risk sentiment and rising metals prices. In the medium-term, we haven't changed ourview. China's property sector is at risk of slowing in the coming quarters given the authorities are starting to show signs of clamping down on the housing market, which would reduce iron ore imports from Australia. Australia's labour market also deteriorated further overnight which, coupled with mining investment staying weak and the housing market slowing next year, means the RBA may need to cut rates to stimulate the economy. With markets having all but priced out hikes next year and iron ore prices falling again, risk reward favors AUD shorts.*
NZD: Outperformance Vs AUD. Neutral.
The RBNZ delivered a hawkish cut last week by bringing rates to 1.75% but removing their easing bias and introducing more two way risk for rates in the future. We expect NZD to range trade for now but outperform AUD. NZD remains vulnerable to a hit to risk appetite or higher US bond yields, however we don't see much risk of additional rate cuts without a hit to the growth outlook. On AUD/NZD New Zealand much more plausibly faces rate hikes than Australia which implies rate differentials can move in its favor. FX intervention remains a larger risk than rate cuts but still remains unlikely and would only be combating further strength.
