USD to remain strong in short term – Nordea Markets

The larger inflation pressure in the US has been one of the sources behind the recent USD resurgence and it has gained versus practically every peer over the last month, as the US outlook has held up in relative terms versus the rest of the world, points out the research team at Nordea Markets.

Key Quotes

“When we look into the crystal ball, there are still good reasons to believe that US core inflation will outpace peers (JPY, GBP & EUR) over the coming 3-5 months, which should act as a continued supporting factor for the USD. We therefore expect the USD to remain in the driver’s seat over the summer, both versus the EUR, the GBP and the JPY, while the GBP will be vulnerable against most peers.”

“But long-term the case for a weaker USD remains intact, as the appeal of US assets could continue to weaken as a result of the US twin deficit and due to the elevated carry costs of hedging the FX exposure of US assets.”

“The weakness in the USD throughout 2017 and early 2018 might have been driven by Fixed Income flows leaving the US, as a result of the higher hedging costs. While this may seem counterintuitive on the surface, higher short USD rates might actually be negative for the USD, as they erode the pick-up in internationals FX hedged US bond portfolios.”

“This is one way of showcasing why EUR/USD can rise further in this business cycle, despite Fed hiking more aggressively than the ECB. We still look for levels around 1.30 or above in EUR/USD (+12-18 months from now).”

“However, we acknowledge that the probability of a broad re-strengthening of the USD has risen and given our short-term positive view on the USD and our less benign view on risk appetite in general, we don’t expect the AUD, NZD and CAD to fare particularly well over our forecast horizon and have adjusted our forecasts accordingly.”