FX Talking: Too much of a good thing

Supreme confidence in the global recovery and central banks in no hurry to tap the breaks have combined to deliver a sizeable bond market sell-off. The adjustment has erred to the disorderly and prompted some adjustment in positioning – especially in FX markets. The currencies most susceptible to this correction have been the low-yielding JPY and CHF – both currencies the least positively correlated with a global recovery.

While March could prove a rocky month for risk assets as US Treasury yields try to find their ‘right level’, our macro team do not buy into the permanence of the much-discussed inflation threat. This means that at some point, a sufficient inflation premium will be priced into bond yields and pro-cyclical currencies allowed to advance again.

In short, this means we regard the current dollar rally as a bear market bounce and remain fully invested in a second-quarter story of a broadening global recovery, which should lift all currencies – including the EUR. A corrective dip in EUR/USD to 1.17/18 should still be followed by a recovery to 1.25 this summer. In Europe, we very much like GBP and CZK.

In the emerging market space, the high yield world looks better placed to withstand a bond tantrum than it did in 2013. Here, the Indonesian rupiah and the Mexican peso are perhaps the most exposed to a further US yield rise in March.

Yet our call is that the current correction is going to provide some attractive entry levels for rejoining core bull trends against the dollar – given that the reflation story, including equity and commodity gains, have much further to run.