Morgan Stanley FX Morning – Global FX Strategy Daily
Next stage of the risk rally. Investors that hadn’t participated in the risk rally may now have been seeing EM and other high-yielding asset benchmark indices outperform their portfolios. The result was a need to try to play catchup by buying the high-beta components of indices. Since late January, EM equity markets have rallied with Brazilian stocks in particular gaining 25%. In the past few weeks, inflows into junk bond funds have largely reversed the outflows we saw from November-February as capital is seeking investment. Most high-yielding assets are benchmarked against the USD, suggesting high-yield inflows weakening the USD on a broader basis. Accordingly, we adjust our risk on trading tactically for now and see the USD trading lower for longer before resuming its long-term uptrend.
AUDUSD to 0.77. We have been risk constructive since the end of January, calling AUDUSD to rally to 0.74. This target is now within sight, but wonder if this currency pair may not have additional potential to rally. It is the fir st time since mid-2014 that AUDUSD has meaningfully traded above its 200DMA, suggesting a clean technical break. This morning’s weak rise in retail sales (0.3%M) suggests caution against getting too bullish in the short term, but with investors willing to take high-yield risk, the AUD is likely to stay bid, opening the potential to 0.77. Sentiment hasn’t fundamentally changed, making the current rally difficult to trade. Sentiment improved due to RMB stability, China’s seasonal purchases of raw materials boosting prices in January and February and the Fed signalling that it is willing to pause for now before hiking rates again. US 10y bond yields falling to a low of 1.52% in February have helped to increase the relative attractiveness of risky but yielding instruments. We note that very little has changed on the data front, as indicated by global PMIs converging towards weaker levels, Asian exports staying weak and EMU’ s bank lending slowing down.
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USDJPY’s reluctant move higher. The BoJ’s Kuroda said that he isn’t considering cutting interest rates further at this point, but added that he stands ready to ease monetary conditions further if required. Obviously, the focus has switched from moving rates further into negative towards using alternative measures. Providing portfolio support by buying REITs, equity ETFs and other private assets could boost the P&Ls of local fund managers and thus increase the tolerance to holding foreign assets (limiting the JPY appreciation). USDJPY should move to the 116-118 area, in our view, but with the USD generally performing weaker, the anticipated USDJPY advance should materialise in a reluctant manner.
EUR risks override the USD move. EURUSD faces resistance at 1.0985 and despite projecting a lower USD in the short term, we see EURUSD failing to break this resistance. The FT is reporting that the EU is close to a migrant deal with Turkey which would see all non-Syrian migrants reaching Greek islands, being returned to Turkey. We will continue to monitor the developments on this front, in particular how other nations debate how to deal with the migrant situation at the 7 March EU summit in Ankara. The discussion will focus on Schengen, which allows passport free travel in EU. A failure to come to an agreement at the summit could push the EUR markedly lower. In addition, next Thursday’ s ECB meeting may add to EUR weakness as President Draghi will likely provide a more downbeat assessment of EMU’ s economy. Our economists still expect a 10bp deposit rate cut and additional EUR20bn/month asset purchases but now don’ t rule out the idea of a tiered depo system, amended TLTROs or talk about buying credit (see ECB Preview).
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