Bearishness on USD remains the general theme in the coming month as driven by a rise in risk appetite and interest rate differentials. However, as many of the G10 currencies' valuations have been stretched, investors may need to be cautious and selective about selling USD.
USD/JPY: The currency will gyrate within a range that is narrower than expected from last month. The selloff of Japanese yen in previous weeks was driven by an increase in investors' risk appetite and position squaring. In the coming term, one of the major themes will continue to be monetary policy tightening by central banks. This indicates the market's growing optimism for an economic recovery and should weigh on Japanese yen. However, the economic outlook in Japan has also improved. Exports of auto and machinery will be boosted by depreciation in the Japanese yen. This would drive capital to the currency, making the overall picture in USD/JPY range bound.
Morgan Stanley remains sidelined on the pair. "The prospect of a sharper global economic recovery, combined with a flat to modestly higher global policy tightening cycle, is positive for risk assets but less so for the counter-cyclical JPY." However, as Japan's "underlying fundamentals remain positive," this "should prevent a significant JPY selloff which may be expected in a typical up-cycle."
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EUR/USD: While the Street has lifted it's forecast on EUR/USD, the current price level (1.413) suggests that the recent rally has been overdone and a pullback to around 1.4 is needed. Moreover, as the euro has risen more than 10% since March, further upside is limited.
Credit Suisse stays "tactically neutral" on the euro, whose "status as the primary alternate reserve currency to the USD has allowed it to stay firm even as rate differentials have moved against it of late, and we expect reserve diversification flows to provide underlying support for the pair going forward." However, it's difficult for the currency pair "to extend its gains absent a more supportive rate backdrop. This in turn may need to await more conclusive evidence that the euro zone is participating in the global recovery."
Morgan Stanley is bullish on the euro and recommends going long EUR/GBP as "the euro area's generally more moderate fiscal position, lack of QE, and a credible ECB policy, combined with more positive lead indicators such as the IFO, suggest that EUR should outperform some of its G10 peers." At the same time, JP Morgan has also raised its forecast on EUR/GBP, saying "There's little scope for GBP to outperform EUR in a recovery, particularly when the Bank of England is signaling no urgency to lift rates."
MORE: What's Ahead for GBP and CHF Versus USD? |pagebreak|
GBP/USD: Although the British pound has retreated almost -4% after making a ten-month high above 1.7 in early August, current price levels remain slightly above the fair value as anticipated on the Street. Therefore, a pullback will be seen before rise resumes later this year.
After the BOE has extended the asset purchase program to 175B pounds, the market has dramatically lost interest in the pound. The majority of analysts on the Street have forecast the pound to depreciate against the euro. All of Credit Suisse, Morgan Stanley, and JP Morgan recommended going long EUR/GBP.
Credit Suisse revised the three-month EUR/GBP forecast from 0.84 to 0.89. The investment bank based the previous forecast "on an expectation for markets to price the BOE to end QE by the end of this year and begin raising its policy rate ahead of other European central banks early next year." Unfortunately, the quarterly inflation report released in August suggested that this is unlikely. Credit Suisse writes: "Markets will have to push out the timing of potential rate hikes substantially, reducing interest rate support for sterling."
Barclays Capital is relatively bullish on the pound. "At 0.86, EUR/GBP is still trading at a significant premium to where it needs to be in the medium run for the UK and euro zone economies to be able to address the balance sheet issues that both face... medium run level is likely to be around the 0.77-0.80 range."
Going into 2010, GBP may rally against the dollar based on the idea that the BOE will increase interest rates faster than the Fed. HSBC forecasts GBP/USD to rise to 1.75 by the end of 2010.
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USD/CHF: While still in progress, SNB's intervention on the appreciation on Swiss franc has been eased recently. Improvement and Switzerland's macroeconomic outlook and appreciation in the euro made the central bank less concerned about the negative impact of strong CHF on the economy. USD/CHF will continue to trade sideways within a range of 1.9-1.1 in the medium term.
Barclays Capital believes the end of the SNB's FX intervention depends crucially upon the inflation outlook. Morgan Stanley and Credit Suisse are neutral on USD/CHF. The former said 'The SNB should be relatively pleased with the recent path of EUR/CHF as it trends higher. The SNB aim to keep EUR/CHF elevated in order to tackle deflation, which has reached -1.2%Y (CPI measure). The pressure for the SNB to intervene has eased and the cross may move higher naturally as the global economic cycle continues to recover," while the latter believed "If EUR/USD continues pushing higher, the SNB may try to prevent USD/CHF from falling much below 1.06. The recent improvement in Switzerland's macro data has been insufficient to lead the Swiss National Bank (SNB) to abandon its policy of preventing CHF appreciation." Credit Suisse continued that "Countering this CHF negative is the mix of a lack of an interest rate spread incentive to recycle Switzerland's current account surplus.this is the bulk of what generates bouts of temporary CHF strength despite speculative positions for franc weakness."
By the Staff at ActionForex.com
