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Some people dismiss FX trends as a random walk, but the market is more capricious than that, drawing patterns and correlations that create the illusion of permanent relationships, only for them to break down and new ones to form. Until the spring, the dollar tracked real long-term interest rates pretty well, but over the summer it has underperformed. It now seems a good time to update our FX forecasts.
In trade-weighted terms, we think further dollar losses from here are an overshoot in the short term, and we look for a small bounce through the end of 2017. But the downtrend isn’t over. Almost exactly 38.2% of the DXY rise since 2011 has now been reversed. Another 5% fall in DXY would take that to 50% and seems likely in 2018.
We expect the euro to lead among the G4 (USD/EUR/JPY/GBP) through next year. Although a pause is likely in the coming weeks, we forecast EURUSD at 1.25 in a year’s time and 1.27 by the end of 2018.
The Swedish krona is also expected to continue outperforming notwithstanding the cautious Riksbank, as the policy implications of the brightening economic outlook in Sweden are all too clear. GBPSEK, in particular, is set to fall further. Meanwhile, the Mexican peso and Turkish lira are among the most undervalued EM currencies, and we expect them to do well going forward.
The Riksbank remains cautious. It is still saying nothing about the end of the government bond purchasing programme at the end of the year, and does not envisage a rate hike before mid-2018.
Consequently, the interest rate path remains unchanged. However, the Bank has raised its growth and inflation forecasts. In future, the CPIF (consumer price index with fixed mortgage rates) will be the inflation target. All in all, the Riksbank's reticence suggests that it wants to wait and see what the ECB does, in order not to risk strong krona gains. Stay short in spot GBPSEK at reference 10.4167, with a strict stop at 10.70 levels and targeting 9.70. A straight forward spot FX trade.
