Navigating FX as major central banks ease further

Major central banks have eased monetary policy further. The Federal Reserve Bank (Fed) cut its target rate by 25 bps while the European Central Bank (ECB) announced a bold and comprehensive package that resulted in more negative rates and the restart of asset purchases.

Effectively, currency markets are likely to grapple with opposing forces: more accommodative monetary policy, which pushes investors towards carry trades (risk-positive), but also ongoing uncertainty revolving around the US-China trade dispute and the recent escalation of tensions in Saudi Arabia (risk-negative).

The dollar will continue to be seen as a safe haven by investors, mostly against cyclical and externally exposed currencies. However, its degree of overvaluation (divergence from rate differentials) has widened considerably and should start to weigh going forward.

More specifically, we maintain a small upside bias for EURUSD over the next few months. Despite the ECB’s bold package, the measures were not enough to supress the common currency. Moreover, rate differentials with the US suggest that EURUSD should be trading somewhat higher while plenty of negative news is already in the price.

We retain our neutral stance on the Swiss franc: risk appetite remains fragile, which will be a positive for the currency; however, the SNB demonstrated that intervening in the FX market remains a live option, at least to arrest any CHF appreciation. As far as sterling is concerned, the recent developments suggest that a no-deal Brexit on 31 October is a very unlikely event. That said, the tail risk has not been removed entirely, which means that GBP still incorporates a sizeable risk premium.

Turning to JPY, there are odds of some consolidation in the near term following its rally earlier in the year and negative JPY seasonality during October and November. However, the cycle is very mature, risk is likely to remain on the defensive, and JPY is still quite undervalued. In that sense, there is scope for further downside in USDJPY from a medium-term perspective.

At the same time, we remain of the view that China has managed the trade disputes with the US in a cautious and controlled manner. This is why USDCNY, after rising close to 7.20, has declined since to below 7.10. Unless frictions intensify, we see little reason for CNY to trade materially weaker.

In the Nordics, we still prefer the NOK over the SEK, while in the core commodity bloc we think AUD has some room to rebound after its multi-month depreciation. CAD is supported by fundamentals and recent developments in oil prices.

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