Quo vadis, dollar?

The dollar rebound in February has admittedly caught us by surprise. We attribute this USD strength to a confluence of factors, including a technical correction and angst about a global slowdown (ex-US) that has proven to be deeper than we expected. We notably think hunt for yield (the carry trade) has helped the dollar against G10 FX, which also explains why higher-yielding EM FX has held up well in the past couple of weeks. This has prompted us to revise a number of our forecasts while maintaining a bearish stance on the greenback.

More specifically, we have lowered our EURUSD forecast trajectory and now see the pair ending the year at 1.20 (1.24 previously). This change is based on a euro-area slowdown that has been sharper and more protracted than we anticipated. It suggests that low-yielding currencies such as the euro will struggle in the near term. However, the external headwinds to the region are likely to abate if the US and China reach a compromise (our central scenario). The subsequent economic recovery should allow the euro to appreciate against the USD which, in our view, remains vulnerable to a rise in US risk premia due to the ballooning twin deficit.

On CHF, we maintain our forecasts unchanged, expecting a very gradual EURCHF appreciation later this year as the SNB retains and potentially intensifies its dovish stance. On sterling, economic data and monetary policy expectations seem irrelevant for now as all that matters is Brexit negotiations. Although we still hold the view of a soft Brexit – which would propel GBP higher – we would point out that the market so far has been fairly complacent as regards the tail risk of a no-deal Brexit.

We have turned slightly cautious on our bullish call for the yen, at least in the near term, as positive developments on the trade front would support risk appetite and penalise safe havens. Eventually, however, USDJPY will end up being a dollar play. This, together with still-wide yen undervaluation, suggests that USDJPY will move south throughout 2019.

In China, we strongly believe that financial stability and thus currency stability continue to reign supreme for the country’s leadership. We remain constructive on the yuan in anticipation of a trade cease-fire between the US and China.

Turning to Nordic currencies, we have revised higher our EURNOK and EURSEK forecasts, but still expect NOK (mostly) and SEK gains this year as we feel monetary policy expectations are currently under-priced. In the commodity FX bloc, our preference remains for the CAD and (less so) for the AUD.