Our top six thematic trades are long USDCNH forwards, long USDKRW NDFs, short EURUSD spot, short AUDUSD spot, long USDBRL 3-month 1x1 call spread and long USDILS spot. Our top relative value trade is short PLNHUF spot.
Implications of a slowing China
We read recent Chinese measures as evidence that officials are accepting that the country’s growth trend has been hit by the build-up of imbalances that can no longer be sustained. We think that a lower Chinese growth trend, more than the cyclical slowdown, opens interesting opportunities for FX markets in the months ahead.
Unsustainable stability
With our valuation models suggesting that the CNY is 5-10% overvalued, and with China’s growth prospects deteriorating, we see risks of capital outflows and CNY depreciation pressure persisting. We think a 10% fall in the CNY versus the USD is needed to stabilize the REER and capital outflows. We recommend a long USDCNH 6-month forward trade and maintain our USDCNH call spread.
Stumbling to a fall
While we remain bearish all commodity currencies, the AUD and NZD look particularly vulnerable to further depreciation. They continue to suffer from slowing Chinese growth, a weaker CNY, lower commodity prices and elevated risk aversion. Furthermore, our recent Dutch Disease analysis suggests these currencies will likely fall much further than previously forecast. As such, we have revised lower our forecast for both currencies and reinitiate our sell AUDUSD recommendation.
Not cheap, given China and Fed risks
Although the current bout of pressure on EM FX is not as extreme as it was in the late 1990s, EMs have been hit by a perfect storm of weak fundamentals. The EM growth differential versus DM has narrowed, external factors have worsened, and external vulnerabilities have increased. There appears to be scope for FX valuations to cheapen and capital to leave EM, especially given the declining reserves adequacy and weak fundamentals in a number of EMs. We have lowered our FX forecasts for vulnerable EMs such as the BRL, TRY, ZAR, MYR and IDR.
Revising the downside
We continue to expect significant further downside in EURUSD, but have revised higher our forecasts to reflect considerable changes to the global outlook and recent EUR resiliency. We see increased downside risks to euro area growth and inflation stemming from a slowing China and expect the ECB to act as a catalyst for a renewed push lower in the EUR. We forecast EURUSD to depreciate to 1.03 by year-end and below parity by Q2 16.
