From Global FX Strategy at Morgan Stanley
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. Certainly we will be focused on policy implementation and upcoming US data but we think the USD is back in its long-term bull trend.
EUR: Bullish on the Crosses. Neutral.
We expect EUR crosses to remain well supported but EUR may have some downside against the USD driven by the rise in US yields, though this downside is likely to be limited as long as the EMU break-up probability does not increase. Trump's surprise win in the US election has put markets' focus back on the reflation theme. As long as the anti-globalisation rhetoric remains subdued, the prospects of rising inflation, supported by the recent tick up in EMU inflation, could bring the ECB tapering debate back on the table, driving EMU yields and consequently the EUR up. The steepening US yield curve may also spill over into the EMU, driving EMU curves steeper which would also support a higher EUR. We continue to expect EUR crosses to trade higher, particularly against JPY.
JPY: Bullish USDJPY. Bearish.
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 ensures that global yield curve steepening pushes rate differentials against JPY. In addition, JPY long positioning has further to unwind. Higher long end US yields may also be accompanied by higher short-term US yields with our expectations for a December rate hike. 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.
Recent developments have stabilised the near-term outlook for GBP, we think. The UK High Court ruling against the government may, subject to a Supreme Court appeal, give Parliament the right to vote on Article 50, which may reduce the risk of a 'hard Brexit' given majority of the MPs were in support of Remain. Additionally, the EU's Brexit Negotiator Barnier saying the EU's Brexit approach will be "neither aggressive or naïve" added some upside for GBP. The BoE has also shifted from a dovish to a neutral stance, limiting the downside for GBP. Coupled with the potential for the market's large short GBP positioning to adjust, we think GBP could stage a rebound in the near term. Accordingly, we hold on to our long GBPJPY position in our portfolio*.
CAD: Vulnerable to Trade. Bearish.
Trump's threats to renegotiate NAFTA has put CAD back into focus. While not nearly as vulnerable as MXN, we think CAD will underperform as a result. 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). Thus, we must watch for the actual implementation of trade policy and as well as upcoming data but we see USDCAD rising from our broad USD view and expect CAD to underperform other commodity currencies.
AUD: Structurally Bearish. Neutral.
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 is also 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 in September, which was a concern for the RBA's new governor. This, coupled with mining investment staying weak and the housing market expected to slow next year, means the RBA may need to cut rates to stimulate the economy.. It is difficult to say when China will slow given the inherent uncertainty of its economy so we are comfortable trading AUD short a little too early to manage this risk.
NZD: Range Trading. Neutral.
The RBNZ delivered a hawkish cut yesterday 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. The growth outlook has improved as have New Zealand's terms of trade. However, NZD remains vulnerable to a hit to risk appetite or higher US bond yields. We don't see much risk of additional rate cuts without a hit to the growth outlook but do see rising risk of FX intervention. The last time the RBNZ sold NZD in large size was 2014 when the TWI was only a bit higher than current levels. It is not our base case but the threat of intervention should limit some further appreciation.
