Euro breaking free from political hurdles

Absent a significant global virus resurgence (or any other “black swan” event), we expect this trend to continue throughout H2 20. Three factors shape our reasoning. First, the pricing out of risk premia as the global economic recovery gets under way in the second half of this year; second, ongoing dollar overvaluation (around 10% based on our estimates) on a trade-weighted basis; and third, a significant shift in euro-area solidarity, cooperation, and fiscal management in periods of crisis.

We maintain our target of 1.17 for the euro-US dollar (EURUSD) by year-end, and see risks to the upside. At the same time, we expect only a gradual euro-Swiss franc (EURCHF) appreciation: pricing out political risk premia in the euro area will be a tailwind, but Switzerland is showing an unwillingness or inability to recycle abroad its sizeable current account surplus. For sterling, we continue to see a bumpy road in the near term, and recovery will materialise only once a basic EU/UK deal becomes imminent. We remain constructive on the Japanese yen (JPY) primarily due to its very attractive valuation.

In the Nordics, we keep our preference for the Norwegian krone (NOK) over the Swedish krona (SEK), due to stronger Norwegian fundamentals. Within the commodity FX bloc, we favour the Australian dollar (AUD) due to its sensitivity to the Chinese business cycle (which is currently in an upswing), and to a lesser extent the Canadian dollar (CAD) and New Zealand dollar (NZD).

The US dollar-Chinese yuan cross (USDCNY) could move towards the bottom of a 6.92-7.16 “tariff-neutral” zone initially before grinding higher as the August Republican and Democratic conventions begin. However, we would expect spot to move back towards 7.00 in Q3. We would view a Biden Presidency (and Democratic sweep) as bullish for the Chinese yuan (CNY), but bearish for the Russian rouble (RUB).

In emerging markets (EM), a sharp turn lower in EM data surprises has seen EM currencies lag behind broader risk assets.

Valuation-wise, we remain neutral on the overall GBIEMFX index (see chart 17), as better growth differentials will be offset by rising debt burdens. We maintain our preference for currencies with healthier fiscal balances and exposure to Chinese infrastructure (Chilean peso – CLP, and South Korean won - KRW), as well as to European growth (Czech koruna - CZK) and to the resilient tech sector (Israeli shekel - ILS). We remain cautious on the Brazilian real (BRL), Columbian peso (COP), South African rand (ZAR), and Turkish lira (TRY) – although the COP could hold up temporarily as the government pursues its FX sales.

Main risks to our USD-bearish view: First, a second strong Covid-19 wave that again disrupts economic activity and increases demand for dollars. While the rise in the US infection rate is worrisome, we think it will prove mostly localised due to transportation restrictions and governments around the world being better prepared. Second, a re-escalation of China-US trade frictions (in the form of new or higher tariffs) would halt the recovery in global trade and would underpin the greenback.

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