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

USD: Limited USD Rally. Neutral.

We maintain our view that the USD will remain weak against EUR, CHF and EM. While recent Fed commentary has continued to be hawkish, US data has been coming in weak, with the latest non-manufacturing ISM figure falling to the lowest level since 2010. Therefore, we continue to think that even if the Fed hikes - which is not our base case - it will be a 'dovish' hike followed by a long pause and the neutral real rate will stay depressed, keeping risk supported and long-term yields low. Given our view that G4 long-end rates, which matter more for EM, will stay low, and the EM-DM growth differential widening over recent quarters, EM inflows will likely stay strong as the hunt for yield continues.

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EUR: Buy EUR Crosses. Bullish.

EUR remains our favourite currency to buy. The latest ECB meeting did not deliver QE extension as expected by most market participants and provided no guidance on the Bank's policy stance after March 2017, helping EUR to rally. While our economists expect the ECB to ease in December, the low-rate and flat-yield-curve environment in EMU prohibits further easing from translating into a weaker EUR. The flat yield curve also hurts EMU banks' profitability, reducing their willingness to take foreign FX risk onto their balance sheets, resulting in the lack of longterm capital exports to offset the inflows from the EMU's current account surplus. We like focusing on buying EUR crosses such as EURJPY, EURAUD and EURCAD.*

JPY: Room for Sell-Off. Neutral.

We have turned more cautious on JPY and see room for USDJPY to rally to 107/108 on the back of market expectations for the BoJ introducing innovative policies at its September meeting. The BoJ has shown signs of changing its approach by reducing long-term bond purchases, helping the JGB curve to steepen. A steeperyield curve helps improve banks' profitability, increasing their ability to take more foreign FX risk onto their balance sheets by buying foreign assets, generating outflows to weaken the JPY. However, we ultimately expect the JPY weakness to reverse if the BoJ sticks to its existing monetary toolbox at the September meeting.

GBP: Data-Heavy Week. Neutral.

We expect the GBP rally could continue, with GBPUSD and GBPJPY potentially reaching 1.35 and 145 respectively. Recent UK data has been surprising on the upside, reducing market fears of a Brexit-related growth slowdown. Our economists now expect UK growth to show an expansion instead of contraction in 3Q. If - as initial data suggests - the weaker GBP has started working its effect on boosting the economy, the data points this week could continue to surprise on the upside, helping GBP to rally. CFTC data shows GBP short positioning is near the historical high, thus a continued rebound in UK data and markets' pricing out of BoE easing could be met by swift appreciation of GBP.

CAD: Bearish Supported by BoC. Bearish.

We remain bearish on CAD, with the latest change in the BoC's stance adding support to ourview. In its latest meeting, the BoC stated that inflation risks have tilted somewhat to the downside and growth may be somewhat lower than anticipated in July, softening the hawkish tone that it had been adopting so far despite weak economic data. This increases the possibility of the BoC cutting rates this year, especially since we are skeptical that exports can rebound enough in the second half of the year for the BoC to hit its forecasts. Given the markets are only pricing in 2bp rate cut for this year, and CAD has the largest long positioning in G10, we think further data weakness could weaken CAD significantly.

AUD: Upside but Cautious. Neutral.

We think AUD may have some more room to rally as the bid foryield continues but we are cautious on the sustainability. First, iron ore prices have started to turn around, which doesn't help the currency. Second, the weak RMB is likely to add to the deflationary pressures within Australia. The RBA kept a neutral tone this week but we think they will have to cut in coming quarters due to the lack of inflation in the country. We prefer to trade AUD crosses so are still long EURAUD and see downside for AUDNZD. Australia's 2Q GDP did not contract but was largely supported by fiscal spending, suggesting there is a risk the growth is not sustainable.

NZD: Increased Migration Supports Consumption. Bullish.

There are many reasons to be bullish on the NZD. The first one is technical, as the NZD is the highest beta currency in G10 so when the USD weakens, the NZD strengthens. Fundamentally, dairy prices continue to rise, the housing markets remains supported and consumption data is coming in strong. The prime minister this week made comments suggesting the country is encouraging more migration which should continue to help with the housing market and construction industry. Inflation remains low, but even if the RBNZ cuts rates, it is difficult for the central bank to weaken the currency in a time when markets are looking for anything high yield. Foreign participation in the New Zealand bond market declined last quarter so there is room for a pickup, driving up the currency, if nearby Asian yields remain low.