Focus of the day:
USD: Data Strength Supports Currency. Bullish.
Watch: ISM, Factory Orders, Trade balance.
US bond yields have started to move higher and this should be supportive for the USD, in our view. US data has been strong with better-than-expected GDP growth and wages picking up, both of which are supportive for a recovery in the economy and for the USD. We remain bullish on the USD against low-yielding currencies dealing with disinflation: CHF, EUR, and SEK.
EUR: Watch the Asset Flows. Bearish.
Watch: ECB, German Factory Orders.
We remain bearish on EURUSD, seeing major previous supporting factors for the currency starting to crumble. In our opinion, the EUR is exposed as European assets look less attractive to foreigners on a risk-reward basis. Three flows into Europe are slowing, in our view: purchases of peripheral bonds, purchases of equities and central bank reserve diversification into EUR. There is also the potential for increased FX hedging of existing holding of European assets, another EUR negative.
JPY: Change to Bearish View. Bearish.
Watch: BoJ Rates Decision, Leading Index, Trade Balance.
We have changed our view on USD/JPY and the recent break higher suggests there is some upside momentum. Economic data has been soft recently suggesting that the BoJ could act earlier than the market expects in order to boost inflation and defend Abenomics. With limited domestic inflation potential, Japan needs to import inflation and this requires a weaker JPY. However, JPY weakness should not be as significant as in 2013 and the BoJ’s ability to purchase long end JGBs is limited.
GBP: Scope for Further Longs. Bullish.
Watch: Industrial Production, BoE Rates Decision.
USD strength has pushed cable back below 1.70, but we maintain our buy dips strategy for GBP. The IMF recently drew attention to the UK’s current account deficit, driving a sell off in the currency, but we note that much of the current account weakness is driven by income rather than trade. What’s more the UK has only a small net foreign liability position, so there is little risk of a sudden stop in funding. As a result, we are cautious on recent GBP weakness.
AUD: Downside Risks. Neutral.
Watch: RBA Rates Decision, Employment.
The more challenging global investment environment developing as a result of higher US yields has triggered a sharp decline in AUDUSD. Indeed, the break lower from the recent range has weakened the outlook, therefore we see some near-term downside risks. The Australian terms of trade data have continued to deteriorate sharply in 2Q, while building approvals have also slowed. The risk to our view is that inflows into Australian bond markets keep AUD supported.