There are still headwinds for the EUR – the delay in ECB policy normalisation, low inflation and weak growth – but we see some recovery in the second half. GBP will track the Brexit saga, where we still anticipate an orderly withdrawal. In Japan, dovish monetary policy and soft growth should delay any JPY recovery.
Trade-weighted USD to peak mid-year
There has been a shift in a number of factors driving trends in the US dollar, but we believe that its cycle highs still lie ahead. We expect it to remain resilient in the coming quarter.
Although the US is still experiencing stronger growth and higher inflation than its peers, the differential in each should narrow in coming months. In addition, safe-haven flows into the dollar are less likely given receding economic tail risks, lower chance of a no-deal Brexit and the likelihood of a US-China trade agreement.
In contrast, hopes that monetary policy differentials would begin to narrow this year have been dashed. Although the Fed seems set to remain on hold for the rest of the year, other major central banks have also taken a dovish stance, most notably the ECB which has suggested it could delay its first hike to 2020. With several EM central banks having turned dovish, US rates should continue to attract inflows.
Additionally, the US administration could favour less market- disruptive policies ahead of the 2020 elections. Moreover, recent extremes in sentiment and positioning have eased, providing further dollar support. Finally, twin deficit concerns no longer seem to top the agenda.
Our fundamental models suggest that conditions for a peak are not yet in place, especially against the euro and the yen. However, we still expect USD to lose ground later in 2019.
EURUSD: under pressure in Q2
We expect the euro to remain under pressure in Q2 due to the delay in ECB normalisation, persistently low inflation, and mixed economic data. Moreover, a number of risks will linger: Brexit uncertainties, elections in Spain and for the European Parliament, and the threat of US auto tariffs.
We still expect these constraints to abate later this year allowing the euro to recover somewhat. We have slightly lowered our EURUSD targets to 1.11 in three months and 1.15 in a year.
GBPUSD: Undervalued, but all hinges on Brexit
GBP remains Brexit-dependent. Our core scenario remains a “soft” Brexit – either via approval of an amended withdrawal agreement (WA) or via extended negotiations along new lines. Either would likely trigger a GBP rally. If a snap election and/or a second referendum is called, we would also expect some sterling strength. Of course, a “no-deal” outcome – the default option if the withdrawal agreement fails and the UK parliament proves unable to agree on a way forward in time – would be a clear negative for GBP.
GBPUSD remains undervalued in our view, and we expect a rate hike within a year horizon. We see GBPUSD at 1.32 in three months and 1.35 in a year.
USDJPY: Delayed reaction
The BoJ could hardly be more dovish and will likely remain on hold at least until it can assess the impact from next October’s VAT hike. Mixed economic data and July’s upper-house elections could also weigh on JPY in our view. Furthermore, we see no shift in investor outflows in search of higher yields abroad. Finally, we expect the JPY’s safe-haven appeal to wane if the US and China strike a trade deal. We see USDJPY trading around 110.
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