FX Monthly: It’s all about sterling

What a month. While we have held a defensive bias in recent quarters (via JPY longs), Q3’s two major pressure points – fears of a no-deal Brexit and an escalating Sino-US trade war - appear to have eased over these past two weeks. While still early days, we think this presents some opportunities in the FX markets. We take these in turn.

First, the ongoing Brexit bruising has been enough to give anyone a nosebleed. But last week, the UK and the EU finally managed to reach a new deal at the EU summit of 17-18 October. This has propelled sterling crosses significantly higher, with GBPUSD up by 5% on a month-to-date basis and EURGBP lower by around 3%.

As of the time of writing, the House of Commons has not yet approved the deal. However, a number of safeguards put in place to avoid the UK crashing out of the EU suggest that the probability of a no-deal Brexit is fading. As discussed in our Investment Committee Update, this has shifted us to a more positive view on the GBP: indeed, the pricing out of the “no-deal” Brexit premium alongside GBP’s significant undervaluation suggested to us that the risk-reward was in favour of sterling appreciation. We maintain this view and look for a gradual GBPUSD appreciation towards 1.35 with the risk skewed towards more upside.

Second, turning to China, the ceasefire achieved with the US on their trade disputes in early October supports our view of USDCNY stabilisation around the 7.10 level in the near term. If we are right in thinking that the admittedly modest Chinese credit stimulus helps commodity FX, this will present opportunities for AUD and CAD to gain.

Given the discussion above, we decided to take profit in our long-held long JPY exposure in our portfolios. USDJPY remains overvalued but a stabilisation in US yields, renewed Japanese equity outflows and negative JPY Q4 seasonality suggests the pair could hold up better for the remainder of the year.

Third, elsewhere, some things have remained the same. We retain the view that the dollar remains subject to opposing forces in the near term (headwinds to global activity vs. USD’s overvaluation). However, the risks that seemed to have underpinned the greenback these past few months (trade war escalation and a disorderly Brexit) are abating. This reinforces our view of USD weakness on a medium term horizon.

On EURUSD, we have trimmed our year-end EURUSD forecast, as the industrial woes – up until Q3 19 - are likely to make it difficult for the currency to make convincing headway in the near term. However, as the global economy stabilises and bottoms out, the currency is likely to gain more traction and shrug off some of the externally driven, priced-in risks. We keep our neutral stance on the Swiss franc and forecast a rather flat trajectory of around 1.10 against the EUR. Risks are for some EURCHF upside.

Finally turning to Nordic currencies, we have lowered our SEK forecast, as the currency will likely be undermined further by the extremely weak domestic data and a likely dovish shift in Riksbank’s stance.

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