GBP/USD: Deutsche Predict GBP to Fall to 1.35-1.40

Exchange rate forecaster's at Deutsche bank see it as the pound's turn to weaken in 2016; whilst they revise up their EUR/USD outlook and discuss potential leading macro themes and their impact on FX.

Strategists at Deutsche have revised up their forecasts for the EUR/USD pair in 2016 based on concerns about a slow-down in China impacting on the Fed’s tightening trajectory:

“EUR/USD is now forecast at 0.95 at the end of 2016, up from our original 0.90 forecast, in recognition of: i) some prospective impact that risk factors like China will have in restraining Fed expectations holding back the USD versus the majors as described above; and, ii) EUR/USD is set to end 2015 slightly above our original projections, setting a higher EUR/USD starting point for future forecasts.”

Deutsche’s team go on to describe two different possible scenarios, the first in which macro themes are dominated by China’s slow-down, and the second in which they are dominated by Fed tightening:

“In macro terms, how 2016 shapes up will be heavily influenced by whether the main macro driver is the Fed or China.

“If Fed tightening is the driver, USD gains are seen as likely to be slow and broad-based, spread fairly evenly between G4 majors, commodity FX and EM FX.

If on the other hand, China, particularly China FX policy becomes a source of instability, USD gains will be heavily concentrated in commodity and EM FX, while the G4 majors all outperform.”

Dollar strength extending multi-year

Deutsche’s strategy team see greenback strength extending over several years, with the dollar’s Trade Weighted Index rising by 10%:

“The multi-year strong USD cycle should extend for at least another 2 years, with a further 10% appreciation in the real broad USD TWI.”

According to their analysis the Greenback has moved in long 6-10 year cycles since the end of the Breton Woods agreement:

“Since the fall of Bretton Woods, big USD down cycles of 9 to 10 years have been followed by big USD upswings of 6 to 7 years.

According to the author’s of the report Alan Ruskin and George Saravelos we are currently just over half-way through an up-cycle:

“While all cycles are different, the macro backdrop conforms to a view that we are about 2/3rds the way through the big USD up cycle, with the real broad index some 50 months into an upswing.

In the same vein, the real Broad TWI has in past cycles largely retraced any prior cycle losses, and increased by 53% and 33% in the 1978 -1985 and 1995 – 2002 upswings respectively.”

According to the FX report the difference with this cycle is the large U.S Dollar gains prior to the first Fed hike:

“The main departure in this cycle relative to past cycles, is that the USD gains before the Fed starts hiking rates have been substantially larger than anything we have seen in any prior Fed hiking cycle.

This front-loading of USD gains fits with more modest USD gains to come.”

Dollar ‘rotation’ Story See’s GBP to USD Weakness as Next Chapter

The dollar’s performance versus other currencies ‘rotates’ according to Deutsche.

It starts with yen weakness, then goes on to the ‘fragile 5’ – the Indian Rupee, SA Rand, Indonesian Rupiah, Turkish Lira and Brazilian Real - and then moves to the euro and commodity currencies.

Two currencies that stand out as having successfully avoided USD strength so far, are the British Pound and the Swiss Franc.

Partly because of this delaying of weakness versus the dollar, Deutsche see weakness ‘catching up’ with them in 2016, especially sterling:

“G10 currencies that have come through this relatively unscathed include the GBP and the CHF, that are both seen as overvalued by most longer-term (PPP, FEER, and BEER metrics)."

It will be the turn of the pound to 'suffer', due to a combination of Brexit fears and fiscal contraction:

“In 2016, the GBP is likely to remain vulnerable most obviously against the USD. The pound in particular should suffer from a mix of fiscal contraction constraining the BOE tightening cycle, making a C/A deficit of near 5% of GDP more difficult to finance, most especially in the face of ‘Brexit’ uncertainties.”

As far as target levels go, the report sees cable falling to 1.35-1.40, “In 2016/7,” and the: “bottom end of the range that has prevailed for 30 years.”