The euro looks weak across the board following this month's ECB meeting. We are bearish the euro outright against the Mexican peso in our global asset class strategy, and maintain our long-held bearish stance on EUR versus GBP.
We see significant upside ahead for Asian FX versus developed world currencies (including the euro, excluding the dollar), particularly on a carry-adjusted basis.
Our bullish view on the South African rand has further to go, with promising technicals and hints of reform generating strong momentum for the currency.
With the Romanian central bank's easing cycle coming to an end, we expect further Romanian leu strength if long-term technical resistance at RON4.4500/EUR is broken.
Given the limited value of regional FX against developed state majors, we also continue to seek relative value within EM FX, as exemplified by our bullish TRY/RUB view in our asset class strategy (up 2.5% since initiation on March 18).
Our major theme this week is potential downside in the euro, versus not just the US dollar but in particular versus EM FX. This is not a new theme - we have long held a bearish euro view, reiterated in timely fashion on April 14 in an article titled 'Time To Short The Euro?' - but we have been awaiting a strong technical signal to go outright bearish. Since last week's ECB meeting, the EUR has looked increasingly as though it has topped out just below USD1.40/EUR, and given carry considerations and the technical outlook, we went bearish the euro versus the Mexican peso (up by around 0.8% since initiation on May 9, as discussed in the Latin America section below).
The ECB took no action at its May 8 monetary policy meeting, though provided the clearest indication yet that it is willing to intervene and ward off the threat posed by persistent low inflation. During the post-meeting press conference, ECB President Mario Draghi stated that the "governing council is comfortable with acting next time". The remarks were somewhat unusual as it can be interpreted as a time-contingent policy intervention and if the ECB fails to act at next month's meeting it risks driving up the euro and denting the central bank's credibility. But we maintain our view that some form of monetary easing will be implemented this year, with further cuts to the refinancing rate or deposit rate being most likely in the first instance.
In any case, we maintain our end-year dollar-euro target of USD1.2700/EUR, as broad-based dollar strength coincides with euro weakness. We also see sterling rising steadily against the euro, with GBP0.75/EUR a very plausible medium-term target from the current level of GBP0.82/EUR.
| Sterling Steaming Ahead |
|Exchange Rate - GBP/EUR|
Asia - Bullish Asian FX Versus DM Basket (Ex-USD): Asian FX is caught between two opposing dynamics at present. On the one hand, the technical picture for many currencies looks bullish, real interest rates are positive across the board, and still-strong current account surpluses offer additional tailwind. On the other hand, the US dollar itself has been in a bull market since 2011. Our global team sees significant potential for the US dollar to rally over the course of 2014 against its developed market peers, thanks to the ongoing tapering of QE and improvements in the current account deficit.
Against the USD we maintain that Asian FX bottomed out in August 2013, and in total return terms will continue to outperform over the coming months and years. However, we believe the real opportunity lies in the potential for Asian FX strength versus other developed market currencies, namely the euro, New Zealand dollar, Canadian dollar, Australian dollar, Swiss Franc and British pound.
| Asian FX To Outperform |
|Asian FX Basket Versus DM FX Basket|
The accompanying chart shows the performance of Asian FX (using an equal-weighted basket of INR, IDR, KRW, SGD, PHP, MYR, TWD, and CNY) versus developed market (DM) FX, excluding the USD (using an equal-weighted basket of EUR, NZD, AUD, CAD, CHF, and GBP). Despite the much stronger economic growth seen in Asia relative to developed markets, the basket of DM currencies sits at an all-time high relative to Asian FX. While higher inflation in Asia accounts for some of this currency underperformance, we still believe that the ratio is set to head strongly in favour of Asian FX.
With the exception of the eurozone and Switzerland, DM currencies run current account deficits. Real interest rates are in negative territory with the exception of Australia and New Zealand, and high fiscal debt burdens mean this is unlikely to change any time soon. The real GDP growth outlook in these countries, meanwhile, is relatively poor. In contrast, Asian economies boast strong current account surpluses and positive real interest rates on the whole, while their fiscal positions are generally solid. While real GDP growth will certainly be slower than it has been in recent years, the region will still outperform from a global perspective. It is difficult to see how DM FX will continue to outperform in the face of these fundamentals, particularly in total return terms, given the much higher carry on offer across Asian currencies.
Latin America - Maintaining Our Preference For The Mexican Peso: We continue to prefer those currencies in Latin America that will see accelerating domestic economies this year compared to last, are relatively more tied to strengthening US economic growth, and whose exports are insulated from the slowdown in Chinese fixed investment. Specifically, we believe that both the Colombian and Mexican pesos will see macroeconomic tailwinds this year, although in the case of the former we expect that the central bank will act to prevent major currency appreciation past COP1,900/USD in order to protect Colombia's non-oil exports. Given our strong outlook for the latter, we turned bullish the Mexican peso (MXN) against the euro (EUR) in our Asset Class Strategy on May 9.
We believe that the break of resistance at MXN17.95/EUR on May 8 marks the end of a year-long depreciatory trend for the peso against the euro, and see a move towards MXN17.00/EUR in the coming months. Sentiment towards Mexican assets has improved since President Enrique Peña Nieto sent secondary legislation for energy sector reform to congress on April 30, assuaging investor concerns that the opening of the hydrocarbons sector to foreign investment would be delayed. In addition, economic activity is picking up in Mexico following a weak Q113, and positive economic data out of the US is likely to further support appetite for Mexican assets, given the robust economic and investment ties between the two countries.
| Break Of Resistance Marks An Inflection Point In Favour Of MXN |
|Exchange Rate, MXN/EUR|
Conversely, the euro looks fundamentally weak as markets anticipate looser policy from the European Central Bank (ECB) in June, following dovish comments by ECB Governor Mario Draghi on May 8 amid deflationary risks. From a technical standpoint, the euro's break of support against the dollar at USD1.3800/EUR will likely further contribute to negative sentiment towards the unit. However, were we to see the MXN/EUR cross rate break through support around MXN18.25/EUR, it could mark the beginning of a larger move in favour of the euro, and would likely cause us to reconsider our assumptions on this view.
We have also seen two currencies on which we have more negative fundamental outlooks - the Brazilian real and the Chilean peso - head towards key resistance. Our core view is that the real will respect resistance around BRL2.1900/USD, but in light of positive risk sentiment we could see the unit could plausibly head higher toward its October 2013 high of BRL2.1400/USD. Similarly, the Chilean peso is right on resistance at CLP550.00/USD, likely benefitting from a relatively high inflation print, which has reduced expectations of further monetary easing from the Banco Central de Chile. A sustained rally could set up a move to the CLP535.00/USD level. However, over the next several months, we continue to expect that sluggish domestic growth, slowing fixed investment in China, and falling industrial metals prices will result in weaker average exchange rates this year for these two currencies.
Emerging Europe - RON Looks Good: Central European FX offers limited appeal against developed state currencies, due to the threat of further monetary easing or delayed tightening amidst a period of low inflation. The main exception is the Romanian leu, which has weathered recent EM volatility thanks to a healthy carry and robust export growth. With the National Bank of Romania (NBR) recently holding its policy rate at 3.50%, in our view signalling the end of its cutting cycle, we expect further RON strength if long-term technical resistance at RON4.4500/EUR is broken.
| RON Benefitting From Healthy Carry |
|Romania - RON/EUR Exchange Rate|
We see less value in the Hungarian forint and the Czech Koruna (where policy rates are 2.5% and 0.025% respectively). HUF appreciatory momentum looks to have halted, and a recent move into deflation is likely to prompt increasingly dovish rhetoric from the central bank. Similarly, the Czech Republic's move towards deflation has increased the likelihood of FX intervention being extended beyond early 2015, severely limiting the appeal of the currency. The Polish zloty should fare slightly better, due to our expectations of a rate hike in Q115, although delayed tightening expectations will ensure that the currency remains broadly flat against the euro in 2014. Given the limited value of regional FX against developed state majors, we continue to seek relative value within EM FX, played through our bullish TRY versus RUB view in our asset class strategy (up 2.5% since initiation on March 18).
Sub-Saharan Africa - Still Bullish Rand: We hold a bullish view on the South African rand, initiated on April 9, on the back of promising technicals and the potential for reform-friendly political change. To date, this view is up by 1.0%, having been given a significant boost last week by the peaceful legislative election on May 7, and by a statement from scandal-prone President Jacob Zuma making vague promises of reform to come. The president said in the days leading up to the election: 'There are things you need to remove so you can move faster… I won't be specific.'
| A Bullish Break |
|South Africa - Exchange Rate, ZAR/USD|
The technicals continue to look promising, with the rand moving firmly through key resistance at ZAR10.5000/USD on May 8. We highlight ZAR10.0000/USD as the next critical level, representing longer-term resistance and a key psychological barrier. A break through here would be a very bullish signal. The most likely driver of such a move would be signs of economic reforms, perhaps involving the ruling African National Congress ousting Zuma from the presidency.
We have another currency view in our asset class strategy table, and that is our long-held bearish outlook on the Ghanaian cedi. The rationale behind this view, initiated in November 2011, was the widening trade deficit and lack of local confidence, and this outlook is little changed now. Although we forecast that Ghana's current account deficit will shrink as a proportion of GDP, from 14.5% in 2013 to 11.4% in 2014, it will nevertheless remain sizeable, and this will continue to exert downward pressure on the cedi. We see little chance of a turnaround for the cedi. Investment inflows into Ghana will at best stabilise and might even decline in 2014, as investors grow wary of the weak macroeconomic situation, with a wide fiscal deficit and rising debt levels, in addition to the aforementioned current account deficit.
Global Asset Class Strategy - FX
| Region || View || Entry Date || Entry Level || Gain/(Loss) |
| Asia || Bearish CNY 12-Month Non-Deliverable Forward || 27-Jan-2014 || 6.11500 || 1.9% |
| Asia || Bearish NZD Versus USD || 29-Apr-2014 || 0.85300 || -1.1% |
| Americas/Europe || Bullish MXN vs EUR || 09-May-14 || 17.90 || 0.8% |
| Americas/Europe || Bearish CAD vs GBP || 23-Sep-13 || 1.6490 || 12.1% |
| Europe || Bullish TRY vs RUB || 18-Mar-2014 || 16.40 || 2.5% |
| Sub-Saharan Africa || Bearish GHS vs US$ || 30-Nov-2011 || 1.6655 || 71.7% |
| Sub-Saharan Africa || Bullish ZAR vs USD || 09-Apr-2014 || 10.4638 || -0.5% |
| Enter table source |