The Fed’s clear shift to a pause in its tightening cycle has been welcomed by beleaguered risk assets. After a torrid end-year for asset markets, investors are using this window to put money to work – especially in undervalued emerging currencies. This benign environment may continue into February, but will prove tentative
While our core theme for 2019 is that the dollar will peak, we believe that’s more a story for 2H19. Before then we expect the market to re-price one to two Fed hikes. These will be driven by sufficiently strong US data and core inflation heading up to 2.5% this summer. Bearish re-steepening of the US Treasury curve should drive some fresh dollar strength over coming months – largely against the low yielding EUR and JPY.
We expect EUR/USD to trade back to 1.12 over coming months on the back of modest dollar strength. There’s very little to say about the EUR right now apart from: (a) politics look to be on the back-burner until European parliamentary elections in May and (b) weak growth does not present Europe as an obvious beneficiary of the investor rotation out of US asset markets and the dollar.
The biggest positive surprise to European currencies (not our baseline) could emerge from Brexit discussions – were a policy path to a second referendum to develop. There is very little clarity on this – but GBP-led gains in EUR/USD to the 1.18 area is an outside risk.