3 FX Convictions – Time for Draghi to deliver - 04 March 2016

have come more into focus. In addition, news that London Mayor and Conservative political

heavy weight Boris Johnson will campaign for UK exit from the EU was seen as increasing

chances of a Brexit. As a result sterling fell sharply; GBP/USD dropped to even below 1.40

and EUR/GBP surpassed 0.79. Recently, sentiment has calmed somewhat resulting in a slight

recovery of sterling. Although a Brexit is not our base scenario, we have been negative on

sterling versus the US dollar since November 2015 because of a delay in BoE rate hikes, a

weaker economy and fears about Brexit ahead of the referendum. As such our short sterling

versus US dollar high conviction view has been our top-performing trade this year. We expect

GBP/USD to move towards 1.35 ahead of the referendum. However, in the case of no Brexit,

sterling could recover sharply as the risk premium is being priced out. Therefore, we have

adjusted our end-2016 GBP forecasts. We have recently published a note on the impact of

various Brexit scenarios (see Macro Focus – Brexit Scenarios).

We added long NOK versus euro on 19 February 2016

We have added a new high conviction call: long Norwegian krone versus the euro (short

EUR/NOK) on 19 February 2016. For a start, our energy analyst expects a recovery in oil

prices during the course of this year. This will give a boost to the sentiment for currencies of

oil exporting countries such as the Russian ruble, Mexican peso and the Norwegian krone.

Norway has relatively strong fundamentals compared to other oil exporting countries, as it has

a fiscal surplus and current account surplus. In addition, although we expect the Norges bank

to cut policy rates by 25bp in March, most of this is already reflected in the price. It is likely the

last cut in the cycle and this would be an insurance rate cut. If oil prices recover as we expect,

the Norges bank will likely become less dovish as inflation is close to target. The Norwegian

economy is more geared towards the eurozone than the US. We have already in place

positions with exposure to the US economy and to the US dollar. A new position in EUR/NOK

will therefore diversify our calls as well as an indirect position for an oil price recovery. Last but

not least, the Norwegian krone is cheap in terms of valuation. The Purchasing Power Parity

level is around 8.15 in EUR/NOK. In short, we expect the ECB to be more dovish than the

Norges bank this year and oil prices to recover. In addition, the Norwegian krone is relatively

cheap. Therefore, we enter long Norwegian krone versus euro as high conviction view. We

place our stop loss at 10.

Yen’s resilience to be temporary

Since the Bank of Japan (BoJ) introduced negative interest rates on 29 January 2016, the

Japanese yen (JPY) has defied gravity. A deterioration in investor sentiment pushed the yen

to 111 against the US dollar. Afterwards the yen has eased to around 114 versus the US

dollar. However, taking into account the overall improvement in sentiment, the yen has

remained relatively resilient. One would have expected a much weaker yen versus the US

dollar in the current environment. The reasons for this behaviour are a bit unclear. Therefore,

we have raised our stop loss in USD/JPY from 110 to 112.

Nevertheless, we expect the yen to weaken going forward because of an improvement in

investor sentiment, more easing by the BoJ and Japanese investors turn abroad for higher

return. Indeed, the Government Pension Investment Fund (GPIF) reported that in the quarter

4 FX Convictions – Time for Draghi to deliver - 04 March 2016

ending December 2015, they have continued to reduce their holdings in domestic bonds and

increased allocations to domestic equities and foreign assets. With domestic yields under

pressure since the Bank of Japan (BoJ) introduced negative interest rates on 29 January, we

expect the GPIF and other insurers to increase their purchases or overseas assets in search

for higher yielding assets. Data from the Ministry of Finance also showed that domestic

investors have increased purchase of overseas assets in the month of February after the BoJ

introduced negative interest rates on 29 January. This will be negative for the yen as their

foreign currency exposures are not fully hedged.

GPIF investment allocation shift Outward investments from Japan have increased

% JPY bn

Source: GPIF, *FB: Foreign bonds; FS: Foreign stocks; DB: Domestic bonds; DS: Domestic stocks

Source: MoF, Japan

Both the BoJ Governor and Deputy Governor have recently stated that they are unlikely to

lower interest rates further in the next monetary policy meeting this month. This is priced in by

financial markets. However, we do not rule out that other monetary stimulus including an

enhancement of their qualitative and quantitative easing program will be announced. They are

also likely to reinforce that even lower interest rates remains on the cards. In our view, lower

deposit rates, further increase in the size of qualitative and quantitative easing program and

ETF purchases will result in an indirect weakness of the yen.

RBNZ dovish bias to weigh on NZD

We maintain our bearish view on the New Zealand dollar (NZD). The business confidence and

outlook indicators declined in February that are weaker than when the RBNZ last cut the OCR

by 25bp to 2.5% in December last year. In addition, consumer confidence and inflation

expectations have also eased lower. Furthermore, key commodity export prices remain weak

and the NZD is stronger than the RBNZ’s forecast by about 4%. However, we expect the

RBNZ to keep the OCR unchanged this month as the unemployment rate in the last quarter of

2015 was surprisingly better than the central bank’s estimate. We also suspect that the RBNZ

would want to wait for house price gains to slow further before easing again. As financial

markets are pricing in about 20% probability that the RBNZ will ease next week, a relief

recovery in the NZD is possible. However, we expect the RBNZ to strike a dovish tone next

week and signal their discomfort on the exchange rate. Upside in the NZD is likely to be

0

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Jap purchase foreign bonds Jap purchase foreign stocks