January: Euro Gains To Continue In H1 13‏

We stick to our view that among the major currencies, the euro will be the top pick in the currency market in H1 13. The combination of i) fewer tail risks attached to the single currency, ii) the ECB rejecting all calls for further easing of monetary policy and iii) a general strong risk sentiment, are all factors pointing to further euro performance even after the strong start to the year.

Hence, we continue to see upside for EUR/USD, EUR/GBP, EUR/JPY and now also EUR/CHF. However, on a 1M horizon, cautiousness is warranted ahead of the debt ceiling discussions in the US, which could give some temporary support to defensive currencies.

EUR/CHF has broken higher recently in a move that appears to have caught most investors by surprise. Fundamental flows (e.g. Switzerland's large current account surplus) remain franc supportive but the reduction in euro tail-risks has opened the window for a potential significant franc depreciation. A lot of money went into Switzerland during 2012 in response to increased global and European uncertainty and there is little evidence that these flows have been fully unwound. This leaves potential for a bigger move higher in EUR/CHF.

Note that the trend could become self-fulfilling, as spot losses could be interpreted by investors as increasing the risk of future spot losses and hence trigger a further unwinding of long franc positions. We are long EUR/CHF via our FX Top Trades 2013 for a 1.25 target and have opted to lift our 3M and 6M forecasts to 1.26.

The yen has continued to depreciate dramatically and USD/JPY has surprisingly quickly broken above our 88 target for USD/JPY. It now appears that the Bank of Japan (BoJ) will both raise its inflation target from 1% to 2% and expand its asset purchases further at its monetary meeting on 21-22 January.

The implication of the higher inflation target will be that the BoJ will continue its asset purchase programme next year. This will be enough to convince the market that the BoJ remains on an aggressive easing path. We have raised our forecast for USD/JPY to 93 (3M), 94 (6m) and 96 (12M).

Although we expect CNY to continue to appreciate moderately against USD in 2013, we still believe we could see a temporarily weaker CNY in coming months where the surplus on China's trade balance seasonally is relatively small. However, CNY has so far appreciated in 2013 and we have cut our 3M and 6M forecasts for USD/CNY to 6.24 and 6.20, respectively, from 6.26 and 6.22 previously. Our 12M target for USD/CNY remains 6.15.

We have adjusted our near-term (3-6 month) forecast for the Hungarian forint in a somewhat more negative direction. This mostly reflects a shift in general investor sentiment on Hungary and increased uncertainty, particularly regarding the monetary policy outlook in Hungary.

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