FX Forecast Update. Clearing skies for the Scandies. 18 March Follow us on

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1 FX Forecast Update Clearing skies for the Scandies 18 March 2016 Thomas Harr Global Head of FICC Research Christin Tuxen Senior Analyst Morten Helt Senior Analyst Jens Nærvig Pedersen Senior Analyst Kristoffer Kjær Lomholt Analyst Jakob Ekholdt Christensen Chief Analyst Stefan Mellin Senior Analyst Vladimir Miklashevsky Analyst Allan von Mehren Chief Analyst Nicolai Pertou Ringkøbing Assistant Analyst Investment Research Follow us on Important disclosures and certifications are contained from page 31 of this report

2 Forecast review part I EUR/NOK. In the short term, the cross remains highly vulnerable to global risk sentiment. As the Fed now seems to be incorporating global growth concerns to a much larger extent, we think the oil price (and thereby the NOK) downside tail risk has been reduced significantly. However, we maintain the view that markets and not least Norges Bank will have to see clear evidence that the business cycle is turning before a more sustainable NOK appreciation trend can materialise. We expect this to be the story for H2. We now forecast EUR/NOK at 9.40 in 1M (from 9.70), 9.40 in 3M (9.70), 9.30 in 6M (9.40) and 9.00 in 12M (9.10). EUR/SEK: Sweden stands out in growth terms and the krona is fundamentally undervalued. As such, we have a medium-term bullish view on the krona but as the Riksbank maintains an easing bias on already ultra-easy monetary policy, we expect the krona to stay weak over the next couple of months. On the back of growing reluctance to cut rates further, some pickup in inflation and inflation expectations, an increased tolerance to excessive SEK appreciation and improved global risk appetite, we have cut our 1M target to 9.20 (was 9.40), 3M and 6M targets to 9.20 and 9.10 (were 9.30), respectively, and we keep 12M intact at EUR/DKK: Accumulated 30bp of tightening of the policy rate spread to ECB by Danmarks Nationalbank since December, short-term tight DKK liquidity and potential hedging of Brexit risk is starting to weigh on EUR/DKK. We now forecast EUR/DKK at in 1M and in 3M-12M (revised down from ). EUR/USD: With no obvious direction for the cross from relative rates as the Fed is sidelined and the ECB has withdrawn from the currency war, the key driver for the cross from here should be upside from a stretched valuation. This said, in 1-3M we look for range-trading in the interval with a key downside risk being that of a Brexit. However, this is not our base. In our main scenario, EUR/USD will rise in 6-12M despite some upside in US rates further out as EUR-positive fundamentals dominate. We are rolling our forecasts, now looking for 1.14 (previously 1.10) in 6M and 1.18 (previously 1.16) in 12M and stress that it will take a combination of Brexit fears and a marked repricing of the Fed in a more hawkish direction to send the cross below 1.10 near term. EUR/GBP: Given the high uncertainty surrounding the EU referendum, we see risks skewed on the upside for EUR/GBP ahead of 23 June. We raise our 1M and 3M forecast to 0.79 (from 0.78) and maintain 3M at 0.80 and think EUR/GBP may inch even higher ahead of the referendum day. Longer term, the outlook for EUR/GBP very much depends on the outcome of the EU referendum. In our main scenario, we assume a status quo for the UK. This implies that GBP should appreciate immediately after the referendum. We continue to target EUR/GBP at 0.74 in 6M and 0.73 in 12M but stress that these forecasts are subject to significant digital risk. 2

3 Forecast review part II USD/JPY: We now expect the Bank of Japan (BoJ) to cut interest by 20bp on 28 April (previously we called for a cut in July). However, the effect on the currency might be limited in the short run as the BoJ is currently fighting gravity as fundamental factors, flows and stretched valuations provide substantial support for the yen at the moment. We forecast USD/JPY at 112 in 1M (previously 116) and 115 in 3M (previously 117). Over the medium-term horizon, we expect the BoJ to cut interest rates further catching up on negative interest relative to European central banks and we still think that cyclical divergence and relative monetary policy support the case for a higher USD/JPY. We now forecast USD/JPY at 118 in 6-12M (120). EUR/CHF: Pressure on the SNB from ECB easing is fading with the latter having left the exchange/interest rate channel as the key transmission link for monetary policy. This said, EUR/CHF could come under pressure near term on Brexit fears but SNB will fight a significant move lower (it does still have some bold easing tools left). However, our base case (no Brexit) remains that the pair is set for the higher levels warranted by fundamentals and SNB policy and we maintain our 12M target at USD/CNY: China has managed to calm down the markets and dampened capital outflows faster than we expected. While we still look for a trend of weakening versus the USD on diverging monetary policy, we now look for a more gradual path. We have cut our 12M USD/CNY forecast to 6.85 from AUD/USD: The stabilisation in global risk appetite and the latest surge in iron ore prices have sent the cross markedly higher. The move seems overdone according to our models and challenges the economy s transition phase. We now expect a 25bp reduction in the RBA s cash rate target in H2. Also, we still expect higher US rates to weigh on the cross over the coming year. In light of the latest move, we revise our forecasts higher but maintain the same profile. We forecast AUD/USD at 0.74 in 1M (from 0.70), 0.73 in 3M (from 0.69), 0.71 in 6M (from 0.68) and 0.71 in 12M (from 0.68). 3

4 Forecast review part III EMEA. Due to more certainty about the central bank mandate and improvement in global risk sentiment, the EUR/PLN spot has fallen to However, we are a little cautious in the near term due to a possible row with the EU on governance policies and the Swiss franc loan conversion plan. Hence, we see the EUR/PLN trading at 4.30 in 1M-3M (previously 4.45 in 1M and 4.40 in 3M), while strengthening over time to 4.22 in 6M (previously 4.30) and 4.15 in 12M (4.20 previously). A slightly more dovish Hungarian central bank has weakened the outlook for the forint and we now see the EUR/HUF moving to 313 in 1M (312 previously) but then strengthening to 310 in 3M-6M (previously 310 and 305, respectively) and further to 305 in 12M (previously 300) due to a pickup in economic growth followed by a tightening bias of the central bank. USD/RUB. The RUB continues to follow the oil story closely and changes in global risk sentiment driven by major central banks amid their dovish monetary policies. We continue to be bullish on the RUB, adjusting our forecasts to the recent sharp recovery in oil prices and improved risk sentiment. The RUB s free float continues to protect Russia s current account surplus and economy despite probably another year of the slump. The rising oil price prospects, an upward oil futures curve and marginal FX redemptions by the corporate sector, combined with low FX demand by individuals, should also be RUB supportive. We have significantly lowered our USD/RUB profile and see the cross at in 1M (77.80 previously), in 3M (81.00 previously), in 6M (82.50 previously), while cutting the long-end to in 12M (71.00 previously). USD/TRY. We expect the lira to get support in the short and medium term due to improvements in global risk sentiment and rising appetite towards the emerging market assets on a dovish Fed, ECB and BoJ. We see a slight deterioration in the TRY spot in the long run due to rising oil prices and weaker exports, which add to the pressure on the current account deficit. We lower our short- and medium-term forecast for the USD/TRY to 2.85 in 1M (3.01 previously) and 2.90 in 3M (3.10 previously), keep our 6M view unchanged at 2.95 and raise our 12M forecast to 3.00 (2.85 previously). 4

5 EUR/NOK short term volatile, medium to long term lower Growth. While Q4 15 GDP figures were roughly in line with expectations, negative revisions to the previous quarters pulled total 2015 growth down to 1.0%, leaving a somewhat larger output gap going into 2016 than expected. The Regional Network Survey points to roughly zero growth in the private sector over the coming months, leaving public consumption as the primary driver of growth in the coming months. The oil investment surveys pointed to a larger fall in 2016 oil investments, despite cost-cutting having significantly reduced break-even prices of Norwegian oil projects. Finally the weaker NOK has temporarily driven core inflation to record high levels (February print at 3.4% y/y). Monetary policy. As expected, Norges Bank cut the sight deposit rate by 25bp to 0.50% at the March monetary policy meeting. The revised rate path was more dovish than expected and we now expect another rate cut at the June meeting (see next slide for more details). Flows. Foreign banks (proxy for speculative flows) have marginally net sold the NOK over the last month. Valuation. Our PPP models put EUR/NOK at 8.15, suggesting the NOK is fundamentally very cheap. The MEVA model has 8.46 as fair. Risks. In the short term, the biggest risk to our projection is a collapse in oil prices. Medium term, the risk is that the lagged effects of the oil price collapse have a more severe impact on the Norwegian economy than we expect. Kristoffer Kjær Lomholt, Analyst, klom@danskebank.com, Forecast: 9.40 (1M), 9.40 (3M), 9.30 (6M), 9.00 (12M) EUR/NOK Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/NOK 1M 3M 6M 12M Forecast (pct'ile) 9.40 (55%) 9.40 (54%) 9.30 (47%) 9.00 (34%) Fwd. / Consensus 9.39 / / / / % confidence int / / / / % confidence int / / / / Conclusion. While the NOK from a medium- to long-term perspective is undervalued, the short-term outlook continues to be closely tied to global risk appetite both directly (via the EUR s status as a preferred funding currency) and indirectly (via global growth expectations and oil prices). The latest rebound in the oil price has weighed on the cross and as the Fed now to a much larger extent seems to incorporate global growth concerns, we think the oil price (and thereby NOK) down-side tail risk has been reduced significantly. We do, however, maintain the view that markets and not least Norges Bank will have to see clear evidence that the business cycle is turning before a more sustainable NOK appreciation trend can materialise. We expect this to be the story for H2. We now forecast EUR/NOK at 9.40 in 1M (from 9.70), 9.40 in 3M (9.70), 9.30 in 6M (9.40) and 9.00 in 12M (9.10). 5

6 EUR/NOK important issues to watch Norges Bank cuts rates and signals more easing to come As expected, Norges Bank decided to cut the policy rate by 25bp to 0.50% at the March meeting. In the corresponding Monetary Policy Report, the revised rate path has a 100% implied probability of another 25bp rate cut in 2016 and a 20% probability of an additional cut in H1 17. Conditional on no policy changes in May, the Q2 16 average suggests a 50% probability of a rate cut in June Given the rest of the rate path this seems like a reasonable condition. Overall the rate path was a bit more dovish than our expectation and highlights a determination to ease monetary policy further given the current outlook. As a result we now expect Norges Bank to cut rates again in June to 0.25%. Given our own projections at this point (less pessimistic than Norges Bank s) we expect this to mark the bottom in the sight deposit rate. On negative rates the statement read: Should the Norwegian economy be exposed to new major shocks, the Executive Board will, however, not exclude the possibility that the key policy rate may turn negative. This indicates that the threshold for going to NIRP is relatively high although not impossible, should the NOK for instance massively appreciate in the short term New rate path suggests another rate cut in 2016; we think Olsen will pull the trigger in June Source: Norges Bank, Danske Bank Markets Norges Bank re-lifts the I44 forecast NOK and weak for longer As expected Norges Bank lifted its forecast for the import-weighted NOK index (i.e. it has shifted the NOK profile to a weaker level). Notably, the revised I44 projection implies close to an unchanged NOK in the rest of 2016 and then only a gradually stronger NOK during The 2017 appreciation tempo is also lower than previously anticipated. Kristoffer Kjær Lomholt, Analyst, klom@danskebank.com, Source: Norges Bank, Macrobond Financial, Danske Bank Markets 6

7 EUR/SEK on the Riksbank s tolerance to SEK strength Growth. The macroeconomic backdrop for the krona is nothing short of excellent. While the growth outlook has in general been downgraded for most economies, Sweden stands out as maybe the only country where the growth outlook has been upgraded. We see continued strength in 2016, although we are aware of the risk that elevated expectations could become easier to beat. Monetary policy. At the April meeting, we expect the Riksbank to expand its QE programme by another quarter and SEK50bn in response to recent ECB measures and as we expect March inflation to be sufficiently disappointing. We expect low for longer but no further rate cuts. The intervention threat will probably be repeated, although Board members may have grown less prone to using it. Flows. We think SEK demand from exporters, real money investors and hedge funds will cap the upside in EURSEK, or rather support the downside. Valuation. The Swedish krona is substantially undervalued from a medium- to long-term perspective. Risks. Risk-off in the markets could send EURSEK higher than we have outlined. We would not rule out a much faster and stronger rebound in the krona given the constructive macro backdrop and low valuation. To what extent interventions (if pursued) will be effective is uncertain.. Stefan Mellin, Senior Analyst, mell@danskebank.se, Forecast: 9.20 (1M), 9.20 (3M), 9.10 (6M), 9.10 (12M) Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/SEK 1M 3M 6M 12M Forecast (pct'ile) 9.20 (40%) 9.20 (46%) 9.10 (40%) 9.10 (46%) Fwd. / Consensus 9.26 / / / / % confidence int / / / / % confidence int / / / / EUR/SEK Conclusion. We continue to see EUR/SEK being range bound for the next few months but with a downward bias. We have become slightly more bearish with respect to the near-term outlook. Why? First, the ECB was less aggressive with the interest-rate/currency weapon. Second, Cecilia Skingsley communicated a higher tolerance to forecast errors. Third, fears of global/us recession have lessened. Fourth, risk sentiment has stabilised. Hence, our 1M target is 9.20 (was 9.40), our 3M and 6M targets are 9.20 and 9.10, respectively, (were 9.30) and we keep 12M intact at Fundamentals and valuation arguments suggest EUR/SEK will edge lower beyond the 12M horizon. 7

8 EUR/SEK important issues to watch On the Riksbank s tolerance to excessive SEK appreciation In was already clear from the minutes of the previous policy meeting that Mrs Skingsley will have greater acceptance for forecasting errors in the coming months. She reinforced her stance with an interview in Svenska Dagbladet last week. She also communicated a greater tolerance towards SEK appreciation in excess of its own forecast. This makes perfect sense in our view. She even said that she would not necessarily back interventions if the krona were to appreciate substantially on the back of further ECB stimulus as long as it does not adversely affect the economic outlook. Stefan Ingves and Kerstin af Jochnick, to whom the intervention decision has been delegated, may not share her view. However, on balance Skingsley s comments suggest the Board has become less proactive. Time will tell. Stay tuned. So what does all this mean for the near-term SEK outlook? Given that the solid macroeconomic backdrop prevails, which we think it will, EUR/SEK should edge lower on this information. To the extent that the Riksbank is fine with this in our view it should be fine with it as the krona is trading close to its forecast the fair range has shifted down as well, say to Stefan Mellin, Senior Analyst, mell@danskebank.se, Sweden outgrows the rest of the pack Source: Macrobond Financial, Danske Bank Markets Riksbank forecast no contraint on the krona currently Source: Macrobond Financial, Danske Bank Markets 8

9 EUR/DKK below the central rate again FX. In February, Danmarks Nationalbank (DN) sold DKK8bn of FX to cap EUR/DKK upside. Since April 2015, FX intervention Forecast: (1M), (3M), (6M) and (12M) has totalled DKK296bn, leaving the FX reserve at DKK422bn the lowest level since We expect EUR/DKK to trade around the current level on 1M and to fall to on a 3-12M horizon, on the back of a tighter spread to EUR and potential inflow into DKK because of uncertainty regarding the UK EU referendum. We look for DN to cap EUR/DKK downside around Rates. Danmarks Nationalbank (DN) opted not to track the 10bp ECB cut in March thereby narrowing the DKK-EUR interest rate spread. The key policy rate in Denmark thus remains at minus 0.65%. We expect to stay at this level on 12M. In our view though the risk is clearly that the accumulated 30bp of tightening relative to ECB since December has been too aggressive and that downwards pressure on EUR/DKK will emerge, especially if capital starts flowing into DKK as a hedge against the uncertainty regarding the impact on the EUR of the UK EU referendum. In this case we expect DN to follow its normal reaction function, which means DKK10-20bn in inflow will trigger a 10bp cut to minus 0.75%. We still regard this level as the lower bound for the key policy rate. Liquidity. We expect the net position to fall below DKK100bn on 1 April due to large seasonal tax payments, including pensions funds paying tax on capital pensions schemes and corporate tax payments. Source: Macrobond Financial, Danske Bank Markets Flows. In March, DKK is negatively impacted by the strong seasonal effect from Danish corporations paying dividends to investors including foreign investors. The Danish current account surplus was 6.9% of GDP last year. This supports a stronger DKK. We expect a large surplus over the next few years. Conclusion. In our view, EUR/DKK is set to trade on the strong side of the central rate on a 12M horizon with downside risks due to additional easing from the ECB in the coming months. Jens Nærvig Pedersen, Senior Analyst, jenpe@danskebank.dk,

10 EUR/USD higher still on valuation as ECB gives up its euro fight Growth. US data have started to surprise on the upside while that out of Europe continues to disappoint. Notably in the US the manufacturing sector is starting to rebound after months of distress driven by the strong USD and/or depressed energy sector. Monetary policy. The ECB delivered on easing but notably shifted its focus from the exchange/interest rates channel to the bank-lending/credit channel. The latter is not the quick fix for the euro-zone inflation outlook that a further depreciation in the euro may have been, and is a clear signal that the ECB will no longer fight euro strength by all means. Indeed, Draghi and co have clearly stated that the central banks prefer QE rather than further rate cuts as the main easing tool from here. Following the dovish Fed message in March we continue to expect that the Fed will hike only once this year. While this is close to market pricing for 2016, we still believe there could be some upside to short-end US rates down the road as pricing for 2017 is very subdued. Flows. Speculators have become notably less stretched short EUR/USD; this likely increases the sensitivity of the cross to any impetus from relative rates. Valuation. Both our PPP and MEVA model suggest 1.26 is fundamentally justified; thus, the cross is undervalued on both metrics. Risks. The risk of a Brexit is a EUR-negative factor which has yet to be factored more firmly into EUR crosses but could gain traction as the UK June referendum is approaching. Christin Tuxen, Senior Analyst, tux@danskebank.dk, Forecast: 1.12 (1M), 1.12 (3M), 1.14 (6M), 1.18 (12M) Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/USD 1M 3M 6M 12M Forecast (pct'ile) 1.12 (39%) 1.12 (41%) 1.14 (51%) 1.18 (64%) Fwd. / Consensus 1.13 / / / / % confidence int / / / / % confidence int / / / / 1.26 EUR/USD Conclusion. With the Fed set to deliver merely a September hike this year, in our view, the case for USD upside from Fed repricing near term looks increasingly weak. At the same time, the ECB has now given up the fight for further euro depreciation. In the absence of USD support from relative interest rates near term, we are likely in for range-trading in the interval for the pair near term before a more sustained move higher further out. We now look for 1.12 both at a 1M and 3M horizon (prev and 1.08, respectively). Beyond 3M, we continue to stress that fundamental factors not least valuation will drive EUR/USD higher notwithstanding some upward pressure on USD rates. We are rolling in our 6-12M forecasts now looking for 1.14 in 6M (prev. 1.10) and 1.18 in 12M (prev. 1.16). Thus, we no longer expect a sustained dip in the cross to precede a move higher longer term. 10

11 EUR/USD important issues to watch Evaluating the pros and cons of EUR/USD upside In Why EUR/USD is set to rally in 2016: Now is the time to prepare! 3 Feb 2016, we outlined the pros and cons of a EUR/USD rebound. We revisit these arguments here: Relative rates are no longer a clear USD positive as Fed could be repriced in either direction from here. We have previously argued that positioning, hedging flows and the relative cyclical outlook were all favouring the single currency; with the European economic outlook deteriorating and the former two having now to a large extent played out as expected, these are no longer obvious EUR positives. What is left to provide EUR/USD support longer term is thus mainly valuation (cf. MEVA and PPP estimates), current-account flows and terms of trade (provided oil prices stay low for an extended period of time). Brexit risk and the single currency While GBP markets have priced in a significant Brexit risk premium lately, EUR/USD seems largely unaffected. But, in the event of a Brexit (not our base case) EUR crosses will likely be dragged down short term by: i.) political uncertainty reg EU and euro commitment across member states, ii.) negative impact on economic growth from impaired trade relations with the UK, iii.) financial risks given EU banks significant UK exposure. ECB will likely fight the above using QE rather than rates, which should dampen the EUR-negative impact though. Christin Tuxen, Senior Analyst, tux@danskebank.dk, Valuation a key argument for EUR/USD upside still Source: Eviews, Macrobond Financial, Danske Bank Markets EU countries unsurprisingly among the top UK trade partners UK top 10 total trade partners (mn USD, 2014) Source: Bloomberg, Danske Bank Markets 11

12 EUR/GBP Brexit risks set to weigh on GBP ahead of EU referendum Growth. The UK economy grew 0.5% q/q in Q4, driven mainly by consumer and government spending while both investments and exports contracted. It is likely that both GDP growth and employment growth will slow in H1 16 due to increased uncertainties ahead of the referendum which could hamper investments and private consumption. This is also reflected in the business survey where e.g. both manufacturing and service sector PMIs declined in February. UK CPI inflation increased to 0.3% y/y in January from 0.2% y/y in December. CPI inflation and CPI core inflation are expected to remain subdued in Monetary policy. The Bank of England (BoE) kept both the Bank Rate at 0.50% and the stock of purchased assets at GBP375bn in March. As such, the BoE has tied its hands ahead of the EU referendum, and we expect UK money market rates to remain fairly stable. We think there are many reasons for the BoE to stay on hold for an extended period: i) subdued inflation and wage growth, ii) other central banks have adopted a more dovish stance and iii) not least, Brexit uncertainties, to name a few. We still expect the BoE will increase interest rates in Q1 17, but with the great uncertainty surrounding the EU referendum, things could change rapidly after it. The market is pricing the first rate increase in Q2 19. Flows. Investors are speculatively short GBP but positioning is not significantly stretched. Valuation. PPP is around 0.77 while EUR/GBP is overbought, according to our short-term financial models. Risks. The upcoming EU referendum represents a significant event risk to GBP and a medium- to long-term risk factor for the UK economy. Morten Helt, Senior Analyst, mohel@danskebank.dk, Forecast: 0.79(1M), 0.80 (3M), 0.74 (6M) and 0.75 (12M) Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/GBP 1M 3M 6M 12M Forecast (pct'ile) 0.79 (68%) 0.80 (70%) 0.74 (26%) 0.75 (38%) Fwd. / Consensus 0.78 / / / / % confidence int / / / / % confidence int / / / / 0.89 EUR/GBP Conclusion. Given the high uncertainty surrounding the EU referendum, we see risks skewed to the upside for EUR/GBP ahead of 23 June. A substantial Brexit risk premium has already been priced into the FX option market, and further significant GBP selling pressure is not likely to be seen before we come closer to the referendum. However, volatility is likely to remain high and EUR/GBP is likely to be very sensitive to news flow, changes in polls and so on. We forecast EUR/GBP at 0.80 (0.79) in 3M and think it may inch even higher ahead of the referendum day. Longer term, the outlook for EUR/GBP very much depends on the outcome of the EU referendum. In our main scenario, we assume a status quo for the UK, meaning that people vote to remain in the EU. This implies that GBP should appreciate immediately after the referendum. Longer term, we project further EUR/GBP downside driven by relative growth and relative monetary policy. We target EUR/GBP at 0.74 in 6M and 0.73 in 12M but stress that these forecasts are subject to significant digital risk. 12

13 EUR/GBP important issues to watch UK s EU referendum is a significant event risk to GBP The EU referendum represents a significant event risk for GBP. The FX option market s pricing implies that large fluctuations in either direction are highly likely. In a No Brexit scenario, we expect EUR/GBP to appreciate immediately after the referendum. Since mid-november, we have seen a significant divergence between EUR/GBP spot value and our short-term financial model s fair value estimate. Assuming that the spot deviation which has developed since mid- November can be attributed Brexit risk, we estimate that a Brexit risk premium in the magnitude of 3-6pp (median estimate 4.5pp) is currently priced in. This implies that EUR/GBP is likely to drop to the range of in a No Brexit scenario. See FX Strategy: Hedging EUR/GBP exposure in a Brexit risk scenario, 9 March, for more details on Brexit risk premium calculations. In a Brexit scenario, fundamental valuation models suggest that EUR/GBP at 0.90 should not be ruled out Looking at fundamental valuations, both our medium-term models (MEVA) and our PPP-estimate ( long-term fair value ) imply that EUR/GBP currently trades very close to what is assumed to be fair value. Given that exchange rates can deviate substantially from model-based equilibrium levels for prolonged periods of time and only converge slowly towards theoretical fair values, current fundamental valuations do not imply any barrier for further significant increase in EUR/GBP. The confidence bands derived from both our medium-term model and the PPP estimate imply that EUR/GBP as high as 0.90 for a period of time would be stretched but within the norm. Morten Helt, Senior Analyst, mohel@danskebank.dk, Estimated Brexit risk premium (3-6pp) Source: Macrobond Financial, Danske Bank Markets Danske Bank s EUR/GBP PPP estimate Source: Macrobond Financial, Danske Bank Markets 13

14 USD/JPY we expect BoJ to cut by 20bp in April Macro outlook. Japanese GDP contracted 0.3% q/q in Q4 15, and we see a high risk of a technical recession in Q4-Q1 with yet another negative growth rate in Q1. Inflation printed at 0.0% y/y in January and is likely to remain subdued due to the combination of a falling oil price and appreciation of the yen, which has appreciated more than 6% in trade-weighted NEER terms year-to-date. Monetary policy. Given the weak inflation and growth outlook, we maintain the view that more monetary easing is warranted and we have moved forward our call on the BoJ from July to April. We expect it to cut its key policy rate by 20bp to -0.3% on 28 April while keeping its QE programme unchanged at JPY80trn per month. We also think it is likely that the BoJ might scale up its ETF and J-REIT purchases. In particular, the dovish stance from the FOMC but also the more dovish central banks globally, which has caused further JPY appreciation in March, and the prospect that the Shunto wage negotiations might result in weaker pay increases compared to last year are factors that in our view have tipped the balance in favour of additional easing in April when the BoJ publishes its quarterly Outlook Report with updated growth and inflation forecast. Flows. Japan s trade balance improved substantially in 2015 to a current account surplus of 3.3% of GDP, providing increasing support to JPY. Valuation. USD/JPY is significantly overvalued. PPP is around 82, while our MEVA model suggests 104 is fundamentally justified. Risk. USD/JPY remains highly correlated with investors risk appetite. Investors are speculatively long JPY the most stretched long positioning since 2011, suggesting that the cross probably is less sensitive to further sell-off in risk assets. Morten Helt, Senior Analyst, mohel@danskebank.dk, Forecasts: 112(1M), 115 (3M), 118(6M) and 118(12M) Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k USD/JPY 1M 3M 6M 12M Forecast (pct'ile) (53%) (74%) (82%) (76%) Fwd. / Consensus / / / / % confidence int / / / / % confidence int / / / / USD/JPY Conclusion. USD/JPY has continued to fall sharply in March as most other central banks, including the Fed, have turned more dovish. We now expect the BoJ to cut interest by 20bp on 28 April as a response to a weaker growth outlook and the risk of low wage growth. The effect on the currency might be limited in the short run as the BoJ currently is fighting gravity as fundamental factors and flows (among others stemming from a rising current account surplus) and stretched valuations provide substantial support to the yen at the moment. We forecast USD/JPY at 112 in 1M (previously 116) and 115 in 3M (117). Longer term, fiscal headwinds are looming in terms of a possible vat increase in April At the same time, we expect the Fed to resume its hiking cycle in September. This will probably help in turning the tide for the JPY, allowing it to remain significantly undervalued for a prolonged period. Hence, with the support from cyclical divergence and relative monetary policy we continue see a case for a higher USD/JPY over the medium-term horizon. We now forecast USD/JPY at 118 in 6-12M (120). 14

15 USD/JPY important issues to watch Shunto wage negotiations likely to disappoint in 2016 On 16 March, major Japanese companies including Toyota, Mitsubishi Heavy Industries Ltd., Hitachi Ltd. and Panasonic Corp. on 16 March announced that they will offer pay increases of JPY1,500 per month. Last year the companies offered a pay-scale hike of JPY4,000 per month. While the final results remain unknown, the notifications from the major companies so far indicate that this year s 'Shunto' wage negotiations are likely to be a disappointment to the BoJ and a clear threat to the virtuous cycle pursued by the BoJ, where higher wage growth is an important element in the Bank s strategy to drive inflation up to 2%. BoJ to catch up on negative rates relative to Europe With the introduction of a negative interest rate policy the BoJ has added another dimension to its policy framework and can now pursue monetary easing by combining quantitative and qualitative easing (QQE) with negative interest rates. On 16 March, Kuroda in a testimony to parliament explicitly said that it would be theoretically possible to lower the interest rate to - 0.5%. We think that additional BoJ easing will primarily be focused on the interest rates and thereby catching up on negative policy rates relative to European central banks. Moreover, we think it is likely that the BoJ might focus on qualitative measures such as scaling up ETF and J-REIT from the current JPY3trn and JPY90bn, respectively) in order to optimise its asset purchases. Morten Helt, Senior Analyst, mohel@danskebank.dk, Wage growth likely to remain modest Source: Macrobond Financial, Danske Bank Markets BoJ still some way from negative interest rates in Europe Source: Macrobond Financial, Danske Bank Markets 15

16 EUR/CHF Brexit the key risk to a sustained rebound Growth. Data out of Switzerland have made a clear turn for the better over the past month as notably CPI, GDP and employment growth alike surprised on the upside. Moreover, forward-looking indicators such as the KOF index and manufacturing PMI are pointing to a more upbeat outlook than has the case for most of the past year. Monetary policy. The SNB remains in wait-and-see mode with a view to the ECB s next move as focus in Switzerland remains on bringing EUR/CHF further away from overvalued territory. The subdued move on rates from the ECB in March was relief for the SNB as the latter was freed from the task of experimenting with rates below the -0.75% level and/or imposing the current negative deposit rates on a larger number of accounts (also known as the nuclear option ). Should CHF strengthen from here, as a first line of defence intervention will likely be the preferred option for SNB. We expect the SNB to keep both the Libor target midpoint and the sight-deposit rate at -0.75% for the foreseeable future. Flows. Positioning remains broadly neutral on CHF and is less stretched on EUR shorts than at the start of the year. Valuation. PPP is around 1.31, while our MEVA model suggests 1.28 is fundamentally justified; hence, the cross is undervalued on both measures. Risks. In the event of a Brexit, EUR/CHF would most likely move lower, testing the SNB commitment to prevent sustained CHF appreciation. Christin Tuxen, Senior Analyst, tux@danskebank.dk, Forecast: 1.10 (1M), 1.08 (3M), 1.12 (6M) and 1.15 (12M) EUR/CHF 0.95 Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/CHF 1M 3M 6M 12M Forecast (pct'ile) 1.10 (67%) 1.08 (33%) 1.12 (70%) 1.15 (80%) Fwd. / Consensus 1.09 / / / / % confidence int / / / / % confidence int / / / / 1.17 Conclusion. With the ECB moving away from the exchange/interest rate channel for easing policy, the long-standing pressure on the SNB from EUR weakness is fading. EUR/CHF has moved to levels where the SNB is more comfortable that the Swiss export industry is able to cope and recent communication from the SNB suggests that the central bank is less determined to bring about outright CHF weakness, and thus willing to accept EUR/CHF staying at these levels for now. Unless EUR/CHF takes a significant dive, we think SNB will stay put for now. Ahead of the UK s EU referendum EUR/CHF may see a move lower on Brexit fears and we still target 1.08 in 3M. Longer term, we continue to expect fundamentals to support a higher EUR/CHF, with a short-lived relief rally towards 1.12 in 6M (prev. 1.11) as the UK stays in the EU, followed by a move to 1.15 in 12M (unchanged.) 16

17 EUR/CHF important issues to watch ECB left little pressure on the SNB As expected, the SNB kept policy measures unchanged in March after the ECB s easing move being concentrated within the QE/TLTRO sphere left little pressure on the SNB to cut its policy rates further into negative territory. Indeed, with the ECB largely shelving the rates instrument, it is now much less likely to challenge the SNB in its determination to bring EUR/CHF back to the higher levels warranted by fundamentals. While inflation is not expected to return to positive territory before mid 2017 (and this is conditional on the Libor target maintained at -0.75%), we stress that the SNB will likely reserve its limited options to fight CHF appreciation to tail events such as a Brexit (see below). Brexit remains a key CHF risk In the event of Brexit (not our base case) the knee-jerk reaction would most certainly be for FX markets to send EUR/CHF lower due to: i:) the negative impact for EUR crosses generally, ii:) a flight to the traditional safe-havens such as JPY and CHF. SNB would likely use intervention as a first means of leaning against EUR/CHF downside but in the event of sizeable CHF inflows, which it would require a large-scale build-up in the FX reserve to go against, we believe the SNB will take the opportunity to charge negative rates on a larger share of sight-deposit accounts (i.e. employ the so-called nuclear option ). This coupled with intervention should ensure that EUR/CHF does not see a sustained dip below Christin Tuxen, Senior Analyst, tux@danskebank.dk, Market speculation on lower SNB rates largely taken out Market pricing of SNB policy rate in 3M (%) Source: Bloomberg, Danske Bank Markets 3M Libor target mid Brexit risk premium not yet clear in EUR/CHF Source: Macrobond Financial, Danske Bank Markets 17

18 USD/CAD lower on oil and valuation Growth. Pressure on the Canadian economy is mounting from weakness in the US as well as the global economy, low commodity prices and a hesitant stance on monetary policy from the Bank of Canada (BoC). Consequently, employment growth has halted and a slight rise in the unemployment rate is trending upwards. Inflation on the other hand remains relatively stable and close to the BoC s target. However, inflation expectations have been trending lower, which suggests downside risk to inflation outlook. Monetary policy. The BoC remained on hold in March, taking the view that there was a balance of risk regarding the outlook for inflation. On the one hand, the recent rally in the oil price will lend some support to economic activity and inflation, which supports the BoC s analysis that current monetary policy is appropriate. On the other hand, declining inflation expectations and a stronger CAD suggest that the BoC is running the risk of not meeting its inflation target. The market is putting a 40% probability on a 25bp cut from the BoC this year. Flows. Speculative CAD positioning is in short territory. Valuation. Our MEVA estimate for USD/CAD is around 1.19, while our PPP model points to Commodities. Oil constitutes a substantial part of Canadian activity and is generally high-cost. Canada thus stands to lose from a new and lower normal level for the oil price. A large share of Canada s oil is of a poorer quality and trades with a substantial discount to WTI. Jens Nærvig Pedersen, Senior Analyst, jenpe@danskebank.dk, Forecast: 1.32(1M), 1.32(3M), 1.30(6M) and 1.28 (12M) Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k USD/CAD 1M 3M 6M 12M Forecast (pct'ile) 1.32 (71%) 1.32 (65%) 1.30 (55%) 1.28 (49%) Fwd. / Consensus 1.30 / / / / % confidence int / / / / % confidence int / / / / 1.44 USD/CAD Risks. A sudden uptick in oil prices would comfort the BoC. The BoC is set to renew its monetary policy target at end Conclusion. The oil price has rallied on the re-pricing of the path of Federal Reserve rate hikes this year and next year and a decline in USD. Both factors have weighed on USD/CAD over the past month. We see stable USD/CAD in the short-run as we expect oil prices to stay around the current level. On 6M-12M, a recovery in oil prices, a stronger external economic situation and valuation would send USD/CAD lower. 18

19 AUD/USD currency challenges transition, RBA to cut in H2 Growth. Overall, economic data releases have been mixed over the past month. While the labour market has improved for a long period, the latest reports have been more blurry. Also the ABS CAPEX-survey points to a further large fall in mining investments over the coming years, which further challenges the economy s transition. Q4 15 GDP, however, clearly surprised to the upside at 3.0% y/y (consensus 2.5%) with positive revisions. Household and government spending in particular countered the drag from lower investments. Monetary policy. As expected, the Reserve Bank of Australia (RBA) kept the cash rate target unchanged at 2.00% at the March monetary policy meeting. Overall, the statement was almost a copy of the one released at the February meeting: the easing bias related to low inflation was re-iterated, comments on domestic growth remained upbeat and risks of external developments were re-highlighted. The most noteworthy part of the statement was (once again) the comment on the exchange rate, which has been adjusting to the evolving economic outlook. Flows. According to the Commodity Futures Trading Commission IMM data, speculators have recently heavily reduced their bearish AUD positions and are now absolute long the aussie. Valuation. Fundamentally, AUD/USD is no longer overvalued. Our PPP model estimate for AUD/USD is 0.71 and the MEVA model has 0.68 as fair. Risks. The AUD remains exposed to global risk sentiment, global growth worries and developments in China. Kristoffer Kjær Lomholt, Analyst, klom@danskebank.com, Forecast: 0.74 (1M), 0.73 (3M), 0.71 (6M) and 0.71(12M) Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k AUD/USD 1M 3M 6M 12M Forecast (pct'ile) 0.74 (20%) 0.73 (23%) 0.71 (22%) 0.71 (29%) Fwd. / Consensus 0.76 / / / / % confidence int / / / / % confidence int / / / / 0.85 AUD/USD Conclusion. The stabilisation in global risk appetite and the latest surge in iron ore prices have sent the cross markedly higher. The move, however, seems overdone according to our model estimates based on relative rates, risk sentiment and commodity prices. Also the aussie appreciation significantly challenges the economy s transition phase and we now expect a 25bp cash rate reduction in H2. Finally, we expect higher US rates to weigh on the cross going forward. In light of the latest move we revise our forecasts higher but maintain the same profile. We forecast AUD/USD at 0.74 in 1M (from 0.70), 0.73 in 3M (0.69), 0.71 in 6M (0.68) and 0.71 in 12M (0.68). 19

20 NZD/USD bottom in commodity prices to cap downside Growth. Net immigration continues to be supportive for real economic activity in New Zealand, which is progressing relatively steadily despite rising global economic woes. The low CPI inflation should also be viewed in this regard. Falling commodity prices are another factor weighing on inflation. Significantly, inflation declined to 0.1% y/y in Q4 the lowest level since Monetary policy. The RBNZ cut its policy rate by 25bp to 2.25% in March. With inflation currently at the lowest level in 16 years and below RBNZ s inflation target of 1-3% the key worry for RBNZ is that inflation expectations become unanchored, which would make it even more difficult to meet its mandate. Consequently, the market is looking for another 25bp cut in H In our view, the risk is for RBNZ to cut in Q2. Flows. NZD positioning is in short territory. Valuation. Our MEVA estimate is Our FX short-term financial model suggests 0.64 as fair. Commodities. Dairy prices remain low following a decline since the beginning of the year, which is a key worry for the agricultural sector. The change to China s one child policy will likely support demand from China for New Zealand dairy products in the medium term. La Niña weather in H2 16 could disrupt agricultural production this year. Risks. The NZD remains exposed to global risk sentiment and commodity prices: should the former make a turn for the better and/or if a strong La Niña fuels upward pressure on food prices, the RBNZ may adopt a neutral stance. Forecast: 0.68 (1M), 0.68 (3M), 0.69 (6M) and 0.70 (12M) NZD/USD 0.55 Mar-15 Jun-15 Oct-15 Jan-16 Apr-16 Aug-16 Nov-16 Feb-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k NZD/USD 1M 3M 6M 12M Forecast (pct'ile) 0.68 (49%) 0.68 (51%) 0.69 (58%) 0.70 (62%) Fwd. / Consensus 0.68 / / / / % confidence int / / / / % confidence int / / / / 0.77 Conclusion. The March rate cut from RBNZ reversed the course for NZD which has gained support from waning inflation expectations and improvement in global risk sentiment. However, with the risk of a global economic downturn fading and that commodity prices have bottomed, we look for NZD/USD to hold on to recent gains. Towards the end of the year, stronger global economic growth and higher commodity prices will support a higher NZD/USD, around Jens Nærvig Pedersen, Senior Analyst, jenpe@danskebank.dk,

21 USD/CNY more CNY weakness ahead Monetary policy: Chinese growth has shown signs of stabilisation and we look for moderate recovery during 2016 driven by the construction sector, which was experiencing a hard landing over the past year. Home sales have moved higher and inventories of unsold houses have come down. Consumption growth remains robust. After severe depreciation pressure, CNY sentiment has improved after China drew a line in the sand in January by pushing up CNH (offshore) money market rates. We look for the PBoC to cut policy CNY rates over the next 3-6 months to ease the debt burden for Chinese companies and underpin continued robust growth in home sales. FX policy. China has made two important changes to policy over the past year First, the daily reference rate has become more market based. Second, the CNY is now explicitly managed against a basket of currencies rather than just the USD. The change in system coupled with equity market turmoil caused considerable confusion and capital outflows at the beginning of However, capital outflows eased considerably in February and March and CNY has strengthened again versus the USD. While strengthening against the USD the CNY has weakened against the basket (see chart) Valuation. Despite the CNY s appreciation in recent years, we do not regard it as overvalued as 1) China s share of global export markets continues to improve; and 2) China still has a robust current account surplus of 3% of GDP. Risks. There is still a risk that the CNY could depreciate faster if capital outflows pick up again on mounting bank losses or if the economy weakens further. Allan von Mehren, Chief Analyst, alvo@danskebank.com, Forecast: 6.55 (1M), 6.60 (3M), 6.70 (6M) and 6.85 (12M) Source: Macrobond Financial, Danske Bank Markets Conclusion: The PBoC managed to calm the markets faster than expected and the depreciation pressure on CNY versus the USD has eased. We have thus lowered our forecast slightly but still see a 5% depreciation over the next 12 months to 6.85 (a bit weaker than the forward market). We still look for CNY to weaken, though, on divergence in monetary policy between the US and China. The CNH-CNY spread has been eliminated again after the depreciation pressure eased. We expect the spread to stay around zero throughout the forecast horizon. Hence any basis risk in hedging CNY exposure through CNH is expected to be limited. 21