Negative framework for the USD

Since the beginning of the year, the Brazilian Real (BRL, +16%) and the Japanese Yen (JPY, +7.5%) have been  the top performers vs. the EUR, while emerging currencies such as the Turkish Lira (TRY, -16%) and the Mexican Peso (MXN, -15%) remain at the bottom of the rankings as the year’s worst performers. Over the course of the month, however, the USD posted a very strong performance as the greenback outperformed, with rising yields. The GBP also posted good returns after a long period of decline.

Negative framework for the USD

While it is highly likely that the Federal Reserve will raise its rates towards the end of the year, we expect future rate hikes to be gradual (with three in 2017). Furthermore, purchasing power parity against major currencies still indicates that the USD is expensive. Hence the overall picture for the Dollar remains negative.

Supportive framework on the JPY

Though rate differentials remain penalizing, the Yen –  according to our indicators (PPP, trade and capital flows) – appears to be attractive. Furthermore, in the current environment of macro uncertainty and the heavy dose of political/event risk present, the Yen remains an attractive safe haven and diversifying asset.

Positive on the SEK; negative the NZD & AUD

Our framework is positive on the Swedish Krone. With long-term drivers being positive and inflation shooting higher, fundamentals are pointing towards a re-appreciation of the SEK. 

NZD and AUD appear overvalued and long-term drivers suggest more downside for both currencies (PPP overvaluations, current account). It appears that the New Zealand central bank is not entirely comfortable with the strength of the Kiwi (which sharply appreciated in 2016). As a result, we can expect some easing in the form of a rate cut or forward guidance.

Emerging markets: Overweight Latin America FX vs. Underweight Asian Currencies

The US elections ushered in a new paradigm for EMFX –  the expected reflationary and protectionist US policies are posing risks to the gradual Fed normalization and supporting a strong US Dollar in the near term. Most EM central banks remain hawkish and focused on anchoring inflation expectations: The Russian Ruble RUB, the Colombian Peso (COP) and CEE currencies (HUF, PLN, RON) are fully covered by underweights in Asia FX.

Our overweights in COP and RUB are justified by our expectation that commodity FX will outperform EM currencies overall, by the strong external/FX position of the RUB and the upside macro and political risks for the COP.

In this context, we have turned negative on EMFX and long US Dollar, with overweights in commodity FX like the Ruble.

The CEE FX experienced a recent underperformance vs the Euro, but should benefit from the solid growth momentum and strong external sector dynamics (FDI coverage of current account). We have also installed a tactical overweight in the Indonesian Rupiah (IDR) on an attractive valuation, structural reform momentum and cyclical recovery. We have also tactically covered the underweight in the Mexican Peso (MXN) which underperformed dramatically after the US elections but is one of the EM currencies offering the best long-term valuation and could benefit from a sharp unwinding of the short market position.

We are maintaining our structural underweight on Asian currencies. The Chinese Yuan (CNY), due to the liberalization of its capital account and slower growth, is expected to continue depreciating in the medium term. The Thai baht (THB) is also entrenched in a depreciation stance amidst an accommodative monetary policy and deteriorating fundamentals.