FX Monthly: Still cautious on the EUR but risks are to the upside

This month, we have updated our long-term fair valuation model for G10 FX (more details in the pdf). Broadly, we find the dollar still somewhat overvalued (4% in trade-weighted terms), albeit less so than before (6%). On balance, this does not change our general bearish USD view.

We remain cautious on EURUSD but see upside risks to our forecasts (1.14 for the end of the year and 1.16 for Q1 20). Although the increased dovishness by the Federal Reserve Bank (Fed) implies lower US yields, the rate differential with the euro area is still substantial, and with the European Central Bank (ECB) now having signaled that rates could remain negative for longer, the yield differential drag is likely to remain in place for now. However, if the improvement in Chinese data starts spilling over to export demand for the eurozone, then regional data will improve and EURUSD will come under upside pressure – hence our assessment that risks are to the upside.

On CHF, we continue to see a gradual appreciating pressure for EURCHF largely because the back-to-back downgrades in Swiss National Bank (SNB) inflation forecasts communicate a message of increased dovishness by the central bank. On sterling, the long extension of the article 50 deadline (to 31 October), together with cleaner speculative positioning suggests that the recent collapse in implied volatility is likely to stay with us for some time. Fundamentally, we remain GBP bullish, expecting a “no-deal Brexit” to be averted.

On the other side of the world, USDJPY continues to challenge our bearish view, likely due to some recent increase in Japanese buying of foreign stocks. However, the US cycle is very mature and momentum in risk appetite is likely to moderate, which should allow the stretched JPY undervaluation to become the dominant driver and push USDJPY lower. In China, the incoming information clearly points to some stabilisation in the economy, which should bode well for the CNY. We remain constructive.

In the Nordic region, we expect both NOK and SEK to appreciate this year, but to different degrees. Our preferred currency is the NOK, which is supported by strong domestic data, monetary policy tightening, and high oil prices. SEK is likely to lag.

Finally, in the core commodity FX bloc, recent developments suggest that the AUD rally of this past month (which lost steam these past few days) has further to run, especially against the low-yielders. CAD is caught between opposing forces, but oil prices and stabilisation in global trade should help in the next few months. NZD will be the laggard as monetary policy easing is likely to disappointing domestic data.