Greenback, Sterling, Yen: What Should Currency Investors Look Out For This Summer?

Sterling: Small Overweight

Supporting the view

• The pound is undervalued based on purchasing power parity (PPP) measures

• Job creation and wages have been stronger than expected

• Despite Brexit uncertainty, hard data has remained remarkably healthy

• Bank of England is unlikely to make a move in either direction until Brexit situation is clear

• Large political risk premium apparent, with Boris Johnson expected as new prime minister

Risks to the view

• Political uncertainty will likely increase again as the Tory party will likely elect a new leader veering to hard Brexit

• Trade balance suggests that currency weakness is not boosting exports as much as previously expected

• Wage pressures appear to have slowed

• Stock building activity boost may fade

US dollar: Small Underweight

Supporting the view

• Market participants are still long

• The US dollar is overvalued based on PPP metrics

• Fed has taken a dovish stance

• Recent big fall in interest rates should weaken the dollar if sustained when risk appetite normalises

• Core personal consumption expenditure shows no sign of overheating

• Twin deficit fears and political instability

• Slowdown in growth will reduce growth differential

Risks to the view

• Large growth gap versus rest of the world

• Short-term yields are supportive despite recent narrowing versus rest of world

• US economic data is still better than other economies’

• Trade war causes continued risk off

Euro: Underweight

Supporting the view

• The European Central Bank (ECB) has taken a dovish stance – monetary policy should be accommodative for even longer than expected last month

• Large negative carry discourages longs

• Purchasing managers’ indices are still weak

• US has still not properly addressed the proposed tariffs on European cars

• Brexit will still weigh on the euro

Risk to the view

• The ECB cannot reach a decision regarding monetary policy until the new governor has been installed

• Despite deceleration most recently, growth is still expected to be at trend

• The eurozone is a beneficiary of the expected pick-up in global growth in H2

• Large current account surplus

Japanese yen: Overweight

Supporting the view

• Long yen remains a valid trade during periods of risk aversion

• Japanese growth should improve from one-off factors

• Extremely low unemployment should support inflation

• Current account surplus

• PPP and real exchange rates suggest the yen is undervalued

• Falling global yields makes Japanese interest rates less discouraging 

Risks to the view

• Wide yield differentials in both nominal and real terms; Bank of Japan yield curve policy exacerbates the yield differentials against the yen

• Continued rebound in risk assets could lead to further sell-off as hedges are unwound

• Market participants are likely still slightly long

Canadian dollar: Underweight

Supporting the view

• The Canadian dollar is still overvalued based on PPP measures

• Bank of Canada has turned neutral and are in wait-and-see mode

• Wage growth dynamics are uncertain

• Housing market slowdown could cause further instability

• Risk of Chinese boycott of Canadian products due to Huawei arrest

Risks to the view

• Canadian growth has been strong and job creation is good

• Supportive yield differentials

• Business outlook is healthy

• Inbound merger and acquisition activity could increase with NAFTA risk cleared

• Terms of trade have improved recently

Australian dollar: Small Overweight

Supporting the view

• The Australian dollar (AUD) has sold off sharply over the last few months

• Trade balance is supportive

• Terms of trade has improved

• Job growth has been good

• Market participants are very short

• Improvements in Asian sentiment should support the Australian dollar

• Fiscal stimulus and Reserve Bank of Australia (RBA) rate cuts should feed through to activity

• RBA is on hold after having cut twice

Risks to the view

• The AUD is one of the most over-valued currencies in G10 based on PPP measures

• Low realised inflation and wage growth for some time will keep the RBA dovish

• Housing market slowdown in progress

• China slowdown and trade wars could slow growth in the domestic economy and exports

Swiss franc: Underweight 

Supporting the view

• The franc is still very overvalued based on PPP measures

• Safe haven flows should continue to be unwound if European prospects improve

• Strong currency continues to cause low inflation

• The franc is one of the most attractive funding currencies

• Carry should be in favour of growth in current market environment

Risks to the view

• Italian snap election risk

• Positive current account

• Better European growth is positive for the Swiss economy

• Better inflationary dynamics

• Brexit uncertainty supports the franc

• Upcoming US free trade deal may cause the Swiss National Bank to be more cautious on intervention in order to avoid currency manipulator tag

Norwegian krone: Overweight

Supporting the view

• Norwegian krone valuation is attractive

• Better-than-expected employment should boost domestic growth

• The Norges Bank may hike again in the autumn

• Forward-looking data suggest good growth ahead and inflation is above target

• Oil and gas investment intentions have held up despite fall in energy prices

• Terms of trade is recovering after the Q4 fall

• Housing market has stabilised

Risks to the view

• Norges Bank does not dare to deviate from more accommodative policy elsewhere in G10

• Housing market takes another leg lower in the summer

• Employment growth slows

• Trade wars or concerns about European growth and stability cause a decrease in risk appetite

• Lower liquidity over the summer

Swedish Krona: Small Overweight

Supporting the view

• Krona has discounted too much trade weakness versus the current situation

• Inflation dynamics are supportive but are still volatile around target

• The Sveriges Riksbank has begun its hiking cycle

• Hard data are good but moderating – improvement in net exports is important

• The krona's valuation is attractive

• The central bank should be more accepting of some krona strength as the trade-weighted krona is at multi-year lows

Risks to the view

• The Sveriges Riksbank will be cautious while ECB is not tightening

• Negative yield differential against most currencies

• Trade war concerns is negative for open economies

• European data is still challenged

• Lower liquidity over the summer

New Zealand dollar: Small Underweight

Supporting the view

• The New Zealand dollar is overvalued based on long-term fair value measures

• Inflation is not improving as much as expected despite easy monetary policy; Reserve Bank of New Zealand will strike a cautious tone

• Growth may have peaked as immigration slows – evidenced in Q3-Q4

• Employment has slowed and unemployment is trailing higher while wages are still weak

• Dairy prices have retraced recently

Risks to the view

• Growth continues to be decent

• Inflation may have troughed and job growth remains strong

• Fourth highest carry among G10 currencies

• Market participants are modestly short

• Asian sentiment improves either though Chinese stimulus or trade deal