It is that time of year again... for the 10th time we present our FX Top Trades for the year ahead. We include both spot and option strategies with the latter allowing us to express longer-term views when short-term risks are in an opposite direction. As a foundation for all trades, we discuss five themes which we deem will set the agenda for the FX market in 2019. But we supplement these with a wildcard: the risk of a US recession - likely a key market hazard. The themes and the wildcard in turn serve to motivate the specific trades we adopt. The themes are as follows:
Theme #1: Hints from the cycle. Risk assets under pressure near term from growth and tighter monetary policy which suggest positioning selectively for carry and limit short vol exposure. But as the cycle stabilises mid-2019, consider long carry, short vol.
Theme #2: Scandi divergence to continue. Norwegian and Swedish growth and policy cycles may look similar. But Norway is well insulated to a continued global slowdown via the oil sector while Sweden is fragile due to housing and low wage growth.
Theme #3: Demography matters. Yield spreads are on the rise as a split between capital exporters vs importers is evident. Demographic shifts may limit the appreciation pressure for 'surplus' currencies who will need to buy USD assets still.
Theme #4: USD carry is high. But it is set to rise further in 2019 as Fed 'out-hikes' market pricing. Also, Fed's balance-sheet reduction limits the potential for a US debt-ceiling cash deluge and we expect USD carry to rise more than priced by forwards.
Theme #5: Valuation triggers ahead. USD remains overvalued vs GBP, EUR, JPY and most EM currencies. But as more central banks 'normalise' and political risks clear, valuation corrections should play out, supporting GBP, NOK, EUR and CEE.
Wildcard: A US recession. If such a scenario looms, it should fuel marked Fed repricing and USD carry would take a key hit. The associated risk sell-off would likely fuel a stronger JPY and EUR should prove resilient.
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