Escalation of trade war clouds the currency outlook

Things have changed significantly since our last FX Monthly: the US-China trade deal that everyone – ourselves included -- was expecting has so far proven elusive, and each side has imposed fresh tariffs on the other side’s imports. Meanwhile, important Chinese data (Purchasing Managers’ indices (PMIs), investment, industrial production, retail sales) underwhelmed and failed to inspire confidence in a manufacturing rebound. These developments have led us to take a fresh look into our FX views.

Renewed trade tensions are not good news for the euro, which has been battered by the deterioration in the European Monetary Union (EMU)’s external sector. However, the environment is becoming less carry-friendly, meaning that funding currencies (like the euro) are likely to receive some support. We still see EURUSD in a tight range in the near term.

At the same time, the Swiss franc has gained modestly on the back of the deterioration in risk appetite. However, CHF correlation with risk remains fairly low and is unlikely to be able to shield the currency from further weakness as the SNB maintains its very dovish stance.

GBP has been on a rollercoaster; we reaffirm our view that levels around 1.28/29 represent the bottom, but a number of near-term factors pose downside risk to this view. We adjust lower our near term forecasts (next couple of quarters), but medium term we remain bullish, expecting a soft Brexit.

Turning to the JPY, the currency has been the main beneficiary of the recent market turmoil. Low US yields, risk appetite remaining on the defensive, and a still overvalued USDJPY suggest further yen gains, albeit at a slower pace.

In China, the escalation in the US-China trade dispute warrants a more guarded view on the yuan. We still expect the currency’s implicit lower bound to hold in the near term. Farther out, the potential cease-fire still supports the yuan’s modest appreciation towards 6.80 vs USD.

On the Nordics, we maintain a bullish view on the NOK, but lower our SEK forecasts significantly on the back of material domestic economic weakness. We expect substantial NOKSEK upside.

Finally, we have lowered our commodity FX forecast trajectories on account of the escalation in the US-China trade dispute. That said, we still expect some modest upside in AUD and CAD in H2 19 vs the USD. NZD should lag.