Morgan Stanley G10 FX Outlook

Watch: Yellen, New Home Sales, GDP, core PCE
USD has broken out to the upside and we maintain our strategic bullish bias. The FOMC Minutes, while not significantly more hawkish, indicated progression in the debate on the amount of slack in the economy and the possibility of earlier removal of accommodation. As the market remains dovishly priced, we think there is room for further catch up in US yields and USD. After Yellen’s Jackson Hole speech, we will watch next week’s housing data, durable goods, 2Q GDP revision and core PCE.

Little Upside
Watch: Draghi, IFO, M3, Consumer Confidence, CPI, Unemployment
With the ECB remaining dovish, inflation low and growth limited, the EUR remains a sell in our view. Volatility-adjusted bond yields remain unfavourable for foreign investors, limiting inflows and therefore EUR upside potential. We expect that increased foreign investor hedging of their European asset portfolios could bring EUR lower. We will be watching the performance of equity markets and bond inflows because support lost from here would provide a bearish signal for the EUR, in our view.

Q3 Data Key
Watch: Jobless Rate, CPI, Retail Sales, Industrial Production
We still like selling the JPY. We believe that the market is not pricing further easing from the BoJ – so if they do act, it could lead to further JPY weakness. Q2 GDP contracted by 6.8%Y but the composition of the growth suggests the economy has entered Q3 on very weak footing. Next week brings a string of key data for July, including CPI, retail sales and industrial production. Weak data would raise the probability of October BoJ action and JPY weakness.

Long on Crosses
Watch: CBI Reported Sales, GfK Consumer Confidence
While we remain cautious on GBPUSD given our bullish USD view, we like buying GBP on crosses. We believe that much of the long positioning is cleared out, with our Morgan Stanley Positioning Tracker now showing neutral levels for GBP. In addition, the two dissents in the latest set of MPC minutes highlight that there is a real risk of a hike before year end, which should also boost GBP.

An Increase in Foreign Assets?
Watch: KoF Leading Indicator
We believe CHF will trade as a high-beta EUR over coming weeks. The SNB remains committed to the 1.20 EURCHF floor, balancing the risks in favor of a weaker CHF. News that a major Swiss insurance company is looking to expand its overseas business should add to CHF weakness, as it could signify the start of a rise in outflows from Switzerland. Long USDCHF remains one of our preferred trades.

Temporary Support
Watch: CPI, Retail Sales, Current Account, GDP
With an emerging trend of USD strength, we would expect CAD to be increasingly at risk, particularly if US yields start to rise towards the levels suggested by the SEP forecasts. Canadian households could come under pressure should Canadian yields rise in sympathy with US yields, raising mortgage costs. We will watch inflation over the upcoming week to see if the recent rises fade somewhat, as the BoC expects.

RBA’s Stevens Testimony Watched
Watch: New Home Sales, Private Capex, Private Sector Credit
AUD is caught between two forces. On the one hand, demand for relatively high yielding AAA rated bonds is providing some support. On the other hand, falling commodity prices and increasing risks with China’s economy are headwinds. While RBA Governor Stevens did not signal any near-term plans to ease, we are mindful that Australia’s transition from mining to the consumer is likely to prove bumpy. We recommend caution on AUDUSD, but still favor AUDNZD longs.

Commodity Currencies at Risk
Watch: Trade, Food Prices, Building Permits, Business Confidence
Recent NZD data continue to show an economy under pressure. Following the decline in New Zealand’s terms of trade, led by the 41% fall in milk prices witnessed since February, the consumer sentiment index declined 5% on the month. The RBNZ looks increasingly likely to downgrade its economic projections when it meets in September, suggesting that the rate expectation curve will flatten further. We are bearish NZD, and like expressing the view via long AUDNZD.

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