A yield-race to the bottom

The world’s major central banks (the Fed and the ECB) have signalled their willingness to ease policy. In this “race of yields to the bottom”, the US unarguably has more room to cut rates, which is likely to result in further narrowing of the US-RoW yield differential. Assuming that there is no complete breakdown in the US-China trade discussions and manufacturing recovers enough for the world economy to avoid a contraction, we view these developments as broadly USD-negative.

We continue to expect a very gradual EURUSD appreciation towards 1.15 by year-end. Aside from negative USD headwinds, the narrowing of the US-EMU yield differential – even if the ECB cuts rates – should, at the very least, solidly underpin the euro. On positioning, we advocate relative neutrality for the moment as the spot appreciation we envisage is not enough to offset the negative carry.

Turning to the Swiss franc, we believe that the recent rebound will prove unsustainable given deeply negative rates and a firmly dovish SNB. We have pencilled in a very modest uptick in EURCHF to 1.14 by year-end.

In contrast, we have revised our forecasts for GBP substantially. We forecast GBPUSD at 1.27 (from 1.37 previously) as we consider the latest political developments sterling-negative and think it highly probable that GBPUSD will gravitate closer to 1.20 during the summer months.

At the same time, we retain our constructive view on JPY. The currency has risen against every G10 and major EM FX since late April and we see further room for appreciation based on late cycle dynamics, lower US yields, uncertainties on the political and economic fronts, and JPY undervaluation. Our favourite expressions of JPY upside are against the USD and GBP.

On China, we still expect that the authorities will maintain their current guidance on the yuan unless trade talks completely break down. Absent the latter, we expect stability and, further out, some modest depreciation in USDCNY.

On the Nordics, we reiterate our bullish NOK view as domestic activity is on a very strong trajectory. Global uncertainties certainly pose a risk, but we see downside in EURNOK and in USDNOK, and upside in NOKSEK on the back of monetary policy divergence.

Finally, within the commodity FX bloc, the RBA’s increased dovishness poses downside risks to our relatively constructive view on AUD, though we still think that market pricing of monetary policy easing is too aggressive. We maintain a positive stance on the CAD as the labour market is becoming increasingly tight. Finally, we think NZD is likely to gyrate around current levels for the foreseeable future, lacking any catalysts for direction.