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Greenback blues

The US dollar has been hit by slower inflation and policy disappointments in the US, but its weakness may not extend to the year-end

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THE US dollar has fallen victim to in­flation disappointments that led fi­nancial markets to price in fewer Fed fund hikes. With eurozone economic data having closed the gap with the US, eurozone inflation normalising and European political risks materi­ally lower, it is harder to argue for a break-out of euro/US dollar from its recent range. So we have adopted a neutral view and wait for new catalysts before deciding on any new active view on either currency.

Our highest-conviction currencies are the Japanese yen (above all against the Chinese yuan and Australian dollar), the strongly undervalued Swedish krona, under­valued oil currencies like the Norwegian krone or the very cheaply valued South African rand.

US dollar: The US dollar (US$) weakened in H1 2017 against all the major currencies on the back of slower inflation and disappointments from the US administration’s inability to roll out much anticipated expansionary fiscal policies.

However, we believe that solid economic growth prospects and easy financial conditions over the coming months should keep the US Federal Reserve on track to reduce monetary policy accommodation. We expect the Fed to deliver two more 25bps rate hikes over the next 12 months, with the next one likely in December 2017.

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As such, we believe investors should not extrapolate the US$ weakness witnessed in H1 into H2 as the Fed­eral Reserve gradually hikes policy rates and potentially announces balance sheet unwinding in the September policy meeting. Though we have a neutral view on cur­rency, we believe the US$ plays an important yield and diversification role in a diversified FX portfolio.

Euro: While the eurozone’s economic expansion is still supportive, euro strength might come up against some important tests. Early signs of moderation in eurozone data and stabilisation in recent US wage growth data act as a burden. Second, rate futures markets now expect the Fed to hike interest rates only once more than the European Central Bank (ECB) until end-2018. This seems too cautious as we expect gradual Fed tightening to continue with the next hike in December, while the ECB is not expected to hike rates before the end of tapering late next year.

Finally, euro/US$ is now trading not too far from our estimated fair value of around 1.20 and, reflecting the euro’s still significant yield disadvantage, is not cheap on a forward basis.

Overall, we remain neutral on euro/US$ over three months and expect some consolidation around our slightly raised euro/US$ forecast of 1.17.

Swiss franc: The franc has weakened on safe-haven flow unwinding, but incentives for sustained private capital outflows remain limited as the euro’s rate advantage is actually declining. This should contain the franc’s weakness against both the euro and US dollar. We are neutral on the franc versus the euro and US dollar.

British pound: The pound is still undervalued but the weakening UK data and unfavourable rate spreads are  concerns. Brexit discussions contain risks in both directions. We therefore expect a range-bound pound/US$ forecast at 1.30 in three months and 12 months.

Australian dollar: The Reserve Bank of Australia (RBA) signalled caution in normalising monetary policy in lockstep with other central banks, disappointing some hawkish market expectations. The Australian dollar (A$) consolidated its recent gains, but the iron ore recovery and relative Chinese data strength are still positive for the A$. We remain neutral on the A$ versus the US$, and keep our forecasts unchanged at 0.79 over three months and 0.77 over 12 months.

Canadian dollar: The Canadian dollar (C$) has recently reversed some of its strong gains as the lifting effect of the recent hawkish turn at the Bank of Canada (BOC) on Canadian short-term interest rates faded. Canadian fundamentals remain solid amid a robust labour market, and the BOC looks likely to tighten monetary policy further in the coming months. However, future rate markets have already discounted two hikes over the next year.

Japanese yen and Scandies (Swedish krona and Norwegian krone)

Our highest-conviction currencies are the Japanese yen, the strongly undervalued Swedish krona or undervalued oil currencies like the Norwegian krone. We remain posi­tive on the undervalued yen, as it can strengthen on geo­political concerns or a shift in the Bank of Japan’s (BOJ) easing policy.

For now, the BOJ is reluctant to allow Japanese bonds to follow rises in global yields, but pressures could build over time as strong growth continues and inflation rises in the second half of this year. This might be intensified if continuously low approval ratings for Prime Minister Shinzo Abe translate into expectations of leadership change at the BOJ. We forecast US$/yen at 108 over three months and 105 over 12 months.

Valuation remains attractive for the Swedish krona against the euro, US dollar and the Swiss franc, and the cyclical outlook is also positive, in our view. Given strong economic growth and the return of inflation back to­wards target, the Riksbank is likely to cautiously move towards normalisation, probably even slightly ahead of the ECB. The Norwegian krone’s recovery has recently paused amid broader euro strength. The currency re­mains at relatively cheap levels versus the Swiss franc and euro, and can be lifted again on account of recou­pling with the oil price rebound.

Mild depreciation in Sing dollar

As the currency is managed against a basket of global currencies, the recent strength in the euro has provided support on the downside. However, after the strong rally, Singapore dollar (S$) is trading above the mid-point of the S$ NEER policy band. Latest Q2 GDP growth of 2.9 per cent was supported by pick-up in financial services ac­tivity growth. We expect the mix of growth to shift from exports to domestic sectors in H2.

However, the Monetary Authority of Singapore (MAS) is likely to maintain a neutral policy given the weak la­bour market and lack of inflationary pressure. With the Fed expected to hike the policy rate in H2, the higher US yield could weigh on the currency.
Therefore, we maintain our negative view on the cur­rency and expect mild depreciation towards 1.39 over the next three months.

Prefer ringgit in EM Asia FX

In EM Asia FX, we see value in the Malaysian ringgit. The ringgit is our preferred currency in Asia, as fundamentals are improving and valuations are attractive. Malaysia posted its strongest quarterly GDP growth in two years at 5.8 per cent for Q2 2017, supported by a pick-up in private consumption (+7.1 per cent).

Stable Chinese yuan

This is in view of the 19th National Congress in China. GDP growth has surprised to the upside in Q2 by remain­ing stable at the upbeat Q1 level of 6.9 per cent, reflecting stronger than expected growth environment. We expect growth to moderately soften in H2 due to high base ef­fect. A strong or at least stable yuan is in China’s best in­terests ahead of the 19th National Congress to be held in October 2017, and in order to attract investment and in­terest in its multi-trillion-dollar Belt and Road Initiative. Recent statement from policymakers clearly indicates the People’s Bank of China’s view of a stable or slightly ap­preciating bias towards the yuan. We forecast US dollar/yuan at 6.70 over the next three months.

Neutral on US$/Thai baht

The Thai baht has strengthened towards its strongest lev­els since May 2015 as foreigners continue to pour funds into the local bond market. Large current account sur­plus continues to be supportive of the baht in general. We believe it is challenging for the baht to strengthen further from current levels as it could begin to impact Thailand’s efforts to boost the tourism sector. W

John Woods is chief investment officer, Asia Pacific, Credit Suisse

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