EUR, JPY, GBP, CHF, AUD, NZD: Weekly Outlook - Morgan Stanley

EUR: Supported by USD Weakness. Bullish.

EUR has appreciated in the past week on the back of broad USD weakness, which we expect will continue. While US real yields are declining, EUR real yields are rising.

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Despite the recent rally in bond yields, German 10y bonds are still negatively yielding, reducing the elasticity of nominal yields to the downside. This results in EUR real yields rising as global inflation expectations fall faster than nominal yields. Given the ongoing debate about the effectiveness of central banks' negative interest rate policy, EUR nominal yields could also continue to push real yields up in support of EUR. Our favored way to express this bullish EUR view is through long EURGBP positions.*

JPY: Staying Bullish. Bullish.

In the past week, the Japanese authorities announced an expansion of their fiscal and monetary easing measures, but we doubt an increase in the size of these conventional measures will be effective in boosting local inflation expectations. With the BoJ fuelling expectations that the negative interest rate policy may be lifted at its next meeting in a comprehensive review of its current policy, should nominal JPY yields continue to rise, real yields could increase further to strengthen JPY. Our analysis also shows that Japanese investors get the highest returns by FX-hedging purchases of US 10y bonds, which could drive an increase in hedging of existing holdings, pushing USDJPY lower. We expect USDJPY to test the next chart levels of 100.20 and 99.05, targeting our forecast of 97 for the third quarter.

GBP: Front-loaded GBP Weakness. Bearish.

The BoE delivered Thursday with a comprehensive easing package including a 25bp cut, additional QE, corporate bond purchases and the Term Funding Scheme. Possibly more important than the package itself is the fact that most MPC members are expecting, not just willing, to cut rates further based on their forecasts. This aggressive approach is likely to cause more GBP weakness and support our 3Q target of 1.24 for GBPUSD. The BoE appears welcoming of further GBP depreciation despite the likelihood that FX pass-through pushes inflation above target. Should we see a large fiscal response or growth doesn't deteriorate as much as expected, we may then reconsider our bearish near-term GBP view.

CHF: Real Yield Support. Bullish.

In the past week, CHF has strengthened as investors price out the probability of the SNB cutting rates further into negative territory. Should the rally in bond yields continue, this would lift real yields in support of CHF. With CHF's sovereign yield curve almost entirely in negative territory, the downside for nominal yields is also limited, which brings real yields up as global inflation expectations fall faster. Given our expectations for further USD weakness, we like selling USDCHF to hedge against the long list of European political risk events starting from September, as CHF tends to strengthen when the source of risk sell-off originates from within Europe.

AUD: Bullish Following Rate Cut. Bullish.

We have turned bullish AUD in the near term and believe it can continue to rally following the RBA's rate cut. AUD's reaction to the rate cut is telling, given it ended the day over 1% higher against USD despite the rate cut not being fully priced in. As the hunt for yield remains strong and the RBA's lack of an easing bias indicates no easing catalyst any time soon, we expect AUD to appreciate (particularly against USD). Our long-term bearish view remains, but is contingent on the housing cycle turning and slowing growth in China forcing the RBA to cut 50bp further in 1H17.

NZD: Bullish vs. USD. Neutral.

The weak CPI and high TWI have pushed the RBNZ to release an economic update foretelling easing at the August meeting. However, with a full rate cut priced in and the market's continued hunt for yield (see AUD), we don't expect NZD to weaken much even if there is a rate cut. We are also skeptical about the RBNZ's willingness to follow through on substantially more easing than market pricing, and housing remains a concern despite upcoming macro-prudential regulations. We await more clarity from the August MPS and expect that NZD could then outperform if the global search for yield continues