FX Talking: Fed-powered rally has legs
After a couple of months of stability, we look for the dollar bear trend to resume into year-end. EUR/USD should be trading up at 1.20 by that stage after three Fed rate cuts. Even though valuations look stretched in equity and credit markets, we still prefer a benign decline in the dollar and a supported environment for risk assets and activity currencies
Ever since the US July jobs report came in soft, currency markets have taken a glass-half-full view of the global investment environment. Here, investors now welcome a 125-150bp Federal Reserve easing cycle without obvious signs of an impending US recession. We think consensus is right to look for a weaker dollar into year-end as the Fed restarts its easing.
We and markets favour the more benign sell-off in the dollar, where a bullish steepening of the US yield curve and constructive equity markets can keep growth currencies supported. Here, we look for EUR/USD to push up to 1.20 by year-end as seasonal dollar weakness takes hold. The alternative is some disorderly dollar weakness, as seen in April.
And despite headwinds from tariffs and threats from bond markets, monetary policy is still having an important say in G10 FX pricing. That’s why we like the Australian dollar higher still, and sterling can probably hold onto gains a little longer. Equally, we’re bullish on the yen, but changes in the Liberal Democratic Party (LDP) leadership and what it means for Bank of Japan policy are a risk.
Lower US rates and the prospect of more liquidity are keeping the carry trade in demand. Super-high yielders in Egypt and Turkey remain popular here, although Hungary’s forint is riding the coattails of carry demand too. However, we have much greater confidence in the staying power of gains for the Czech koruna rather than the forint.
Elsewhere in emerging markets, we note the People’s Bank of China continuing to guide the renminbi higher amid low volatility conditions. But tariffs, local politics and some overvaluation are providing strong headwinds to the Indian rupee, Indonesian rupiah and the Philippine peso. Latam FX, with its high implied yields, should stay bid in this environment.
