FX Talking: Washington blinks first, but dollar damage is done

Real evidence of a portfolio shift away from US asset markets will emerge with a lag. And any evidence of foreign investors increasing FX hedge ratios on US assets will only ever be anecdotal. But the US policy scare last month – plus the latent fear of another ‘sell America’ moment emerging this summer as unfunded tax cuts proceed through Congress – should now limit the dollar recovery.

By nature of its liquidity and some real fiscal movement in Europe, the euro should be a beneficiary of dollar disillusionment. We now think EUR/USD finds support in the 1.08/1.10 area and heads back to the 1.13/15 region. The defensive yen should also see good demand should USD/JPY trade over 150 again. A lower USD/JPY trend will be helped by the Federal Reserve restarting its easing cycle in September as the Bank of Japan hikes again.

Elsewhere in G10, we like sterling as UK and EU relations improve, thrown together by US isolationism. In the emerging markets space, USD/CNY may explore the lower end of a 7.10-7.40 range – but the People’s Bank of China won’t want a stronger renminbi in a period of deflation. CEE has been dominated by political events in Romania, which remain unresolved. Latam FX has been a relative sea of calm, and its higher yields may still be attractive.

Chris Turner, Global Head of Markets and Regional Head of Research for UK & CEE