BofA's David Woo - EUR/USD Pair a Contrarian Buy

Bank of America's FX and Rates Strategist David Woo believes the euro to dollar exchange rate will appreaciate in value in the wake of a December interest rate rise at the US Federal Reserve.

The debate on the US dollar's outlook over the coming 3 to 6 months rests on what will happen in global FX after the widely-anticipated December interest rate rise at the US Federal Reserve.

"History tells us that the first Fed rate hike often leads to short-term profit-taking in USD longs," Bank of America's David Woo wrote in a recent research note to clients.

Woo advocates buying EUR/USD 3-month 1.10 call options prior to the December FOMC, something of a contrarian call.

The bold contrarian call stands out as different from most analysts who see the dollar rising following the hike.

It looks much less controversial in the wake of the ECB disappointment last week and the Euro squeezed higher says a note on the matter.

Although we remain bearish EUR/USD in the long term and expect it to weaken to 0.95 by end-2016, our year-ahead report saw upside risks in the short term.

The short EUR position ahead of the ECB meeting was not as stretched as it was last March, but it was getting close.

Weakening Renminbi to hold Fed Back

The thrust of BofaAML’s currency outlook for 2016 focuses on expectations of weakness in the Chinese renminbi, especially versus the dollar, due to sharply diverging rate-hike expectations, as the PBOC makes further monetary easing a priority and the Fed begins its tightening cycle.

This view seems to be gaining traction as recent data showed a marked below-expectations fall in Chinese exports in October.

Woo also cites unsustainable levels of corporate debt, at over 100% the size of China’s GDP as further cause for the PBOC to continuing its spell of easing.

He underplays fears a rise in U.S rates would signal disaster for Chinese business who took out U.S debt, however, as companies have moved quickly in recent months to hedge their exposure.

Nevertheless. he sees the subsequent devaluing of the Chinese currency as eventually having a feed-back loop effect on the dollar, as a cheaper renminbi, could potentially lead the Fed to slow down its pace of Fed tightening, and put a break on the dollar’s rise:

“Further monetary easing by Beijing resulting in a shallower Fed easing cycle, could go a long way to convincing investors that the Fed will keep real interest rates lower than in previous cycles.”

With continued real inflation in the U.S still lacking upward momentum, Woo sees long-dated U.S rates as too high, leading to a possible retrenchment of U.S monetary policy after the initial hike.

However, the view is similar to that of handful of 'dollar bears,' such as HSBC’s David Bloom, one of the few analysts calling a top in the greenback:

“Now that the FX market has largely priced in a rate hike for December, the narrative is swiftly transitioning to the ‘peak rate’ debate.”

Société Générale Bullish on the Dollar's Prospects in 2016

A continued dollar rally remains the viewpoint of most analysts, including those at Société Générale, who argue that the dollar will only start to devalue when it gets too expensive for the U.S economy.

They estimate this is unlikely to happen in 2016, however, but would probably be part of a broader market correction – or even crash – as they already see valuations “stretched” in America’s bullish stock market.

“We often hear the bulk of U.S dollar strength is behind us. We find the subliminal message (no longer worth being long) misleading,” says SocGen’s head of rates and FX, Vincent Chaigneau.

The view hinges of a more upbeat outlook for U.S inflation, not shared by Woo’s team; with its focus on remnimbi decline and therefore falling Chinese export prices.

Chaigneau argues that the dollar will remain bid because: “it can,” and that this will act to “contain home-grown inflation,” and he advocates buying the US dollar’s dips in 2016.

However, recent inflation data has not shown particularly ‘bracing’ price rises yet, with inflation at 0.2% yoy in October compared to 0.0% in September, and although above expectations, overall unremarkable.