EM currencies likely to see further gains
The GBP could be subject to renewed volatility around the time of the Brexit vote. We still see GBP/USD moving higher.
The US rate decline has weighed on the USD, while emerging market (EM) growth has been stabilizing. We retain a positive bias on EM FX. Fears of a sharp slowdown in economic activity took a toll on riskier assets and triggered broad-based volatility in December. Since then, some sense of stability has returned, with risk appetite improving as the Federal Reserve (Fed) adopted a more market-friendly tone. The USD weakened across the board as Fed rate hikes were entirely priced out for 2019 and EUR/USD moved higher toward our 1.15 target. Our economists now expect the Fed to hike rates twice later this year. Thus, the repricing of US rates may indeed have gone too far. We believe this should limit USD softness, as economies outside the USA have also seen softer activity data and expectations of policy normalization might therefore be adjusted as well. We maintain a three-month target of 1.15 for EUR/USD. The recent environment also supported the CHF against both the EUR and the USD. Yet, we do not expect EUR/CHF to trade much lower going forward as risk appetite recovers. The JPY emerged as one of the best performing currencies, benefiting from a sharp unwinding of previously extreme short positioning. We do not expect the JPY to post further short-term gains and target a level of 112 for the USD/JPY in three months.
EM FX likely to gain furtherEM FX has profited from the recent decline in US rates, confirming our positive view on EM currencies. The fundamental under- valuation of the EM basket and attractive interest rate differentials should support the recovery further. Growth appears to be stabilizing and looser domestic financial conditions should help ex-China EM growth to weather external headwinds. In Europe, Middle East and Africa, we remain positive on the RUB as economic momentum has picked up, Russia’s external position remains strong and fundamental valuation is cheap. We also keep our positive view on the ZAR, which is supported by cheap fundamental valuation and improving growth. In Asia, the confluence of more dovish expectations for US interest rates and improved sentiment has supported currencies, but we would be cautious about projecting an extended move higher. The US-China trade talks appear to have gone rather well, and market volatility has increased pressure on both sides to come to an agreement. We see USD/CNY at 6.85 and 7.00 in three and twelve months, respectively.
Brexit parliamentary vote to drive GBP outlookBrexit negotiations are back in focus as the UK Parliament meets to vote on the Brexit deal in mid-Feb... We still believe that the UK Parliament will reach a consensus to avoid a no-deal outcome. Indeed, the recent amendment of the budget to limit the government’s tax powers in the event of a no-deal outcome suggests that the Parliament is working to avoid this scenario. On the economic front, activity remains resilient and surveys have surprised to the upside. A Brexit deal would likely allow the Bank of England to normalize policy faster, which would support the GBP. GBP valuations remain very attractive and, with a deal possible, we expect the currency to rebound. We thus keep our positive view on GBP/USD and target a level of 1.33 over three months and 1.40 over twelve months.
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