Morgan Stanley’s G10 FX Walk-Through

Morgan Stanley (MS) have provided their view of G10 currencies at the current juncture.

The investment bank see the Euro on the brink, the Yen a goner, Sterling a buy, the Swissie safe as ever, the Loonie stuck going nowhere, the Aussie falling to the value of ol’-iron and the Kiwi no longer 'nurtured'..

EUR: Inner EU Divergence. Bearish.

A widening difference between the economies of the core and periphery continues to limit the European Central Bank (ECB) , say MS, forcing it to remain in defensive mode to protect its weakest members.

This leads MS to forecast ever narrowing ‘real’ yields in the Euro area due to rising inflation but stubbornly fixed and very low interest rates.

"Real yields" are what remains after you take inflation away from interest, and it is getting ever smaller in the Eurozone.

Real yields are a better quantifier of investor draw than nominal yields, so if they fall the Euro is likely to lose out.

“This should keep EMU real yields low, weighing on EUR. EURUSD has become more negatively correlated with peripheral spreads, so the currency pair could come under pressure should spreads widen again on Eurozone political risks,” said MS.

One proviso – in relation to political risk – is that opinion polls in France continue to show Macron gathering support over Le Pen, which could lower political risk putting more on the table for Euro bulls.

JPY: Sensitive to US Yields. Bearish.

USD/JPY is being called a “buy” by just about anyone within walking distance of a bureau de change – it’s the biggest trade of the moment and MS are with the rest of the pack on this.

“We expect continued weakness in JPY on the back of yield differentials. Our sensitivity analysis suggests that JPY weakens the most as US yields rise, implying further downside as the markets look for higher US rates.”

The BOJ's announcement of the QE, or Rinban as it is known locally, schedule historically has also helped to reduce volatility according to MS, “which could encourage banks to lend more domestically and abroad, weakening JPY.”

GBP: Buying Opportunity. Bullish.

MS take a little bit of a contrarian view on EUR/GBP then the majority, which they see as a sell.

This comes despite the recent key technical trendline break higher.

MS think the Pound has already digested a very hard Brexit outcome.

GBP also tends to rise when US yields do, and US yields are expected to rise on Trump stimulus implementation.

“We view the latest setback in GBP as a buying opportunity. While there may be more Article 50 headlines coming up in the next few weeks, we think a lot of negativity around Brexit is already priced into the currency,” said MS.

They also see the potential for FX reserves to be reallocated from EUR into GBP due to political risks surrounding the French presidential elections and Netherlands general election.

CHF: Political Hedge. Neutral.

The possibility of a political upset in Europe is a very real threat and a win for Le Pen would signal the potential end of the Euro, thus for MS the consummate hedge is EUR/CHF, which will appreciate nicely in the event of a market meltdown.

Although the Swiss National Bank (SNB) can’t stop trying to manipulate the Franc down, EURCHF has actually “remained relatively stable, indicating large selling pressure,” say MS.

“We continue to expect the SNB to smooth the EURCHF downside only to manage volatility and not to manage a level, allowing EURCHF to drift lower,” they add.

In other words, the SNB won’t have the firepower to control the direction of the pair; only to smooth its descent.

CAD; Range-Bound. Neutral

MS don’t see much movement in the Canadian Dollar despite fears Trump may drop the NAFTA trade deal making the currency vulnerable.

“USDCAD may remain range-bound for now as oil is likely to stay within its current range and CAD is relatively insensitive to rising US yields.”

Apart from that they see the large number of CAD bulls as a risk – not of pushing the currency higher, but rather to bailing out and the sudden unwinding that would cause.

“The heavy long positioning in CAD poses a risk, but some of these positions may have been unwound in the past few days as CAD underperformed,” said MS.

AUD: Testing Key Levels. Bearish.

The Aussie Dollar is ‘overpriced’ compared to fair-value models based on interest rate differentials.

This is due to rising iron ore prices pushing up AUD and ‘distorting’ its value.

MS warn this may come to an end now as iron takes a breather and starts going sideways following the end of the Chinese re-stocking season and increasing efforts to regulate speculative activity. Eventually AUD should trade, “closer to where yield differentials suggest it should trade (0.70). The break below 0.7610 should technically signal that a top has been formed,” say MS.

Eventually AUD should trade, “closer to where yield differentials suggest it should trade (0.70). The break below 0.7610 should technically signal that a top has been formed,” say MS.

NZD: Expect Further Downside. Bearish

The 17% fall in dairy prices, which constitute New Zealand’s largest export sector are beginning to weigh on the once mighty Kiwi.

MS also suggest the NZD could lose its carry crown to USD if US interest rates rise.

This explains why they say NZD/USD has become “sensitive to US yields”.

Carry trading is an investment strategy in which investors seek out currencies with high interest rates for the return – it is a major driver of currency demand, and therefore value.

“Our sensitivity analysis indicates that NZDUSD has become more sensitive to US yields in recent weeks, suggesting continued underperformance in NZD as the markets seek higher US rates,” said MS.

Although the central bank has shifted from negative to neutral, MS don’t see them raising rates anytime soon.