Monthly Currency Outlook
The dollar was broadly stable over the past month. The sharp rise in the budget deficit and less potential for rising interest rate spreads suggest that the US currency should gradually converge to 1.22 over the coming year.
United States dollar
We see a number of arguments in favor of a weakening of the US dollar against the euro over the coming year. First, the growth differential and the diverging monetary policy path have been in favor of the dollar over recent quarters but this is now well priced and could even reverse. The sharp rise in the budget deficit and in the government debt also suggest that the US currency should gradually converge to 1.22 (value of 1 euro) which is our 12-month target. The long-term fair value is 1.28 (purchasing power parity estimated by the OECD). The expected reduction in risks related to Italy, Brexit and trade could take some time and this limits the downside for the dollar. We expect 1.16 on a 3 month horizon.
The British pound
In October, Brexit deadlines went on but an agreement has not yet been found. The EU summit in mid-October was expected to bring a breakthrough in negotiations or at least both parties softening their stance and progressing towards the Withdrawal Agreement. Instead of that, both parties stood their ground. Nonetheless, Brexit negotiations advanced in the last part of the month. The EU has removed some contentious phrase of its Brexit plan for Northern Ireland and both parties seem to agree on an option to lengthen the transition period should it prove too short. Given this, the next EU-UK summit (November or December) could see an agreement being signed and both parties pushing the Withdrawal Agreement for approval in parliament. While optimism has increased in recent weeks, we refrain from turning too bullish on the GBP. Important risks still exist, with Withdrawal agreement needed to be ratified by the UK parliament and the transition period that could prove challenging. We maintain our call for the GBP to trade at 0.90 in 3 months (value of 1 EUR) and at 0.88 in 12 months.
The Japanese Yen
Since November, the Japanese Yen (JPY) has been contained around 113 due to the strong DXY, despite the risk-off environment. More recently, the USD/JPY has declined as worries are growing regarding rising signals of a slackening of the global economic growth . The Yen has been supported by an increasing risk aversion in a context of slide in equity prices. In the short-term, the trade tensions are likely to persist and further retaliation rounds cannot be excluded before the situation stabilizes. As a result, we keep the USDJPY target at 110 in 3 months (value of 1 USD). In the longer-term, the stabilization of trade tensions is likely to come along the US Federal Reserve ending its rate hike cycle, the broad dollar index weakening and Japanese portfolio rebalancing. All this is likely to support the yen and we forecast the USD/JPY at 108 in 12 months.