Jens Nærvig Pedersen Senior Analyst Senior Analyst. Vladimir Miklashevsky Senior Analyst

Transcription

1 FX Forecast Update Central bankers snooze amid political risks 16 September 2016 Thomas Harr Global Head of FICC Research Morten Helt Senior Analyst Jens Nærvig Pedersen Senior Analyst Kristoffer Kjær Lomholt Analyst Jakob Ekholdt Christensen Chief Analyst Stefan Mellin Senior Analyst Vladimir Miklashevsky Senior Analyst Allan von Mehren Chief Analyst Christin Tuxen (on-leave) Senior Analyst Minna Emilia Kuusisto Analyst Aila Mihr First Year Analyst Nicolai Pertou Ringkøbing Assistant Analyst Follow us on Investment Research Important disclosures and certifications are contained from page 30 of this report

2 Forecast review part I EUR/NOK. With markets pricing a close-to-zero percent probability of a September rate cut, an unchanged Norges Bank announcement next week is unlikely to spur substantial NOK strength. Also, Norges Bank is likely to leave the door open for rate cuts, partly to maintain a weak NOK amid weak global growth and partly because of heightened uncertainty. While the risk of a Norges Bank cut has fallen significantly, we still think Norges Bank is likely to announce liquidity measures at some point in H2 in order to fight the heightened Nibor policy rate spread driven by regulatory changes in the US. In such a scenario, NOK rates would fall and the NOK weaken. While the economic outlook in Norway has improved, global uncertainties have heightened. As a result, we leave our EUR/NOK forecasts unchanged. EUR/SEK. Fundamentals and valuation are extremely favourable for the krona. Cyclical tailwinds have moderated, which has weighed on the SEK recently. Note however that in relative terms the growth outlook is still supportive of the downside. The Riksbank will match the ECB on QE extension as a way to counter any premature SEK appreciation. This is likely to keep EUR/SEK elevated for longer. We maintain our forecast profile, now at 9.40 in 1M, 9.30 in 3-6M and 9.10 in 12M. EUR/DKK. We forecast EUR/DKK will trade at on 1-12M (revised up from on 1-3M and on 6-12M, respectively). Should renewed DKK appreciation pressure arise, we still look for Danmarks Nationalbank (DN) to cap EUR/DKK downside around by selling DKK in FX intervention. EUR/USD. We keep our EUR/USD forecasts unchanged and still expect EUR/USD to continue to trade in the post-brexit range of in coming months. We target EUR/USD at 1.12 in 1-3M. Longer term, we maintain our long-held view that the undervaluation of the EUR and the wide eurozone-us current account differential are longer term EUR positives. We target 1.14 in 6M and 1.18 in 12M. EUR/GBP. We still expect EUR/GBP to trade higher in coming months, driven not only by Bank of England (BoE) easing but also by the considerable imbalances in the UK economy, not least the significant current account deficit. While data suggest that the UK may avoid recession in H2 16, we still expect the BoE to cut the Bank Rate by 15bp from 0.25% to 0.10% in November but it is a very close call and depends on data. We have revised our 1-6M EUR/GBP forecast slightly lower to 0.87 (previously 0.88) in 1M, 0.88 (previously 0.90) in 3M and 0.92 (previously 0.95) in 6M. 2

3 Forecast review part II USD/JPY. In our main scenario, we expect the Bank of Japan (BoJ) to disappoint relative to market pricing at the 21 September meeting, suggesting that USD/JPY is likely to trade lower in the very near term. We target 101 in 1M and 102 in 3M. Over the medium term, we see USD/JPY in the range of targeting 104 in 6-12M. USD/CNY. We have lifted our forecasts slightly to 6.70 (previously 6.65) +1M, 6.75 (previously 6.70) +3M, 6.85 (previously 6.80) +6M and 7.10 (previously 7.00) +12M. This is mainly a reflection of time and looking for the depreciation trend to continue in coming years. Downward pressure on growth persists and we look for more monetary easing next year, while we expect the Fed to hike rates gradually. EMEA. The post-brexit referendum sentiment has improved, supporting CEE currencies, while the majority of the emerging market universe is closely following expectations regarding the Fed s monetary stance. We expect EUR/PLN to slide to 4.30 in 1M (unchanged) as we do not expect Fed hikes in However, given the robust performance of the Polish economy and possible falling risk premium from a resolution of the stand-off with the EU, we expect EUR/PLN to fall to 4.26 in 6M (previously 4.28) and 4.22 in 12M (unchanged). Our EUR/HUF forecasts are 310 in 1M and 3M (both unchanged), 307 in 6M (previously 308) and 306 on a 12M basis (unchanged). USD/RUB. Russia s currency profited from the post-brexit vote emerging markets rally diverging from the crude price. We continue to be moderately bullish on the RUB in the long term. However, the political risk and possible intensification of Western sanctions should be kept constantly in mind, as possible black swan events could prevail over fundamentals. We keep our USD/RUB profile unchanged and see the cross at in 1M, in 3M, in 6M and in 12M. USD/TRY. Given the prevailing political uncertainty, rising pressure on the central bank and economic slowdown while geopolitical tensions have eased and economic ties with Russia are being restored, we keep our USD/TRY forecasts unchanged at 2.98 in 1M, 3.05 in 3M, 3.07 in 6M and 3.15 in 12M. 3

4 EUR/NOK the economy recovering Growth. The Norges Bank Regional Network Survey for Q3 suggests a much improved economic outlook in Norway, with all sectors facing higher output growth (see overleaf). This is encouraging as monetary policy has implicitly been tightened over the summer with the Nibor policy rate spread widening on the back of regulatory changes in the US money market. Core inflation dropped 0.4pp to 3.3% y/y as the one-off effects in the likes of airfares and food-prices which drove the July surprise dropped back. Finally, house prices have surprised to the upside, driven by not least a tight supply side in Oslo. Monetary policy. In June, Norges Bank left the sight deposit rate unchanged, while at the same time signalling a 100% probability of a September rate cut. However, with the improved growth outlook amid high CPI and housing market inflation we think NB will stay on the sideline in September, though we cannot yet rule out a later rate cut (most likely December) and think NB will mirror current market pricing by presenting a rate path bottoming below the current 0.50%. Flows. Foreign banks (proxy for speculative flows) have net bought the NOK over the past month. From a historical perspective, however, speculative NOK positioning remains neutral. Valuation. While the NOK from a long-term perspective seems fundamentally undervalued, the relative development in unit labour costs suggests much more limited short-term upside potential. Our long-term PPP model has EUR/NOK at 8.19 while MEVA (medium-term) has 9.89 as fair. Risks. The biggest risk factor to our forecast is a global risk-off event that would send the cross higher. Kristoffer Kjær Lomholt, Analyst, klom@danskebank.com, Forecast: 9.30 (1M), 9.30 (3M), 9.10 (6M), 8.90 (12M) Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/NOK 1M 3M 6M 12M Forecast (pct'ile) 9.30 (55%) 9.30 (53%) 9.10 (35%) 8.90 (28%) Fwd. / Consensus 9.29 / / / / % confidence int / / / / % confidence int / / / / EUR/NOK Conclusion. With markets pricing a close-to-zero percent probability of a September rate cut, an unchanged NB announcement next week is unlikely to spur substantial NOK strength. Also NB is likely to leave the door open for rate cuts, which is partly to maintain a weak NOK amid weak global growth and heightened uncertainty. While the risk of a NB cut has fallen significantly, we still think NB is likely to announce liquidity measures at some point in H2 in order to fight the heightened Nibor policy rate spread driven by regulatory changes in the US. In such a scenario NOK rates would fall and the NOK weaken. While the economic outlook in Norway has improved, global uncertainties have heightened. As a result we leave our EUR/NOK forecasts unchanged. 4

5 EUR/NOK important issues to watch Regional Network Survey cancels September rate cut The Norges Bank Regional Network Survey (RNS) showed that the key aggregate output index for the next six months rose to 0.75 (from 0.28 in June) indicating a further improvement in the private sector outlook (see cart to the right). This suggests mainland GDP growing at roughly 0.5 % q/q in Q3 and Q4 (including public sector). This is better than the 0.3% that Norges Bank projected in June when they guaranteed a September rate cut. While over the last month we have argued that the probability of near-term Norges Bank (NB) easing was much closer to 50/50 than the 0% priced in markets, the RNS is in our view the pivotal release that allows NB to remain on the sidelines at the upcoming 22 September meeting. We have therefore changed our call to unchanged rates in September but still think it is likely that in H2 16 NB will more directly address the tight NOK liquidity issues that have driven an implicit monetary tightening in Norway (for more details see The US Money Market Reform: The Scandi angle, 9 August, and Norges Bank Dilemma: Too early to rule out monetary policy easing, 11 August). In terms of the revised rate path that NB will present next week, we think Governor Olsen will leave open the probability of a rate cut in December (i.e. roughly 50/50). This is close to current market pricing. RNS details: In terms of growth divisions, all sector outlooks improved relative to the Q2 survey, with the Export industry and Construction in particular jumping from the Q2 survey. It is especially important that the Commercial sector outlook has improved further, since this sector makes up close to onethird of the economy. The regional indices still point to large differences although the outlook in the Western oil-heavy parts looks much better than at the beginning of this year. In sum, the details of the report are also encouraging which supports unchanged rates in September. The growth outlook has improved significantly Source: Macrobond Financial, Norges Bank, Danske Bank Markets and all sector outlooks have improved Source : Macrobond Financial, Danske Bank Markets Kristoffer Kjær Lomholt, Analyst, klom@danskebank.dk,

6 EUR/SEK lower but slower Growth. Swedish GDP growth has moderated, weighing on the SEK over the summer. We look for GDP growth of around 3% for This would be above trend and peers but less spectacular than last year. Net exports remains a drag. Private consumption and fixed investments remain key drivers, albeit to a lesser extent. Monetary policy. As expected the Riksbank left policy unchanged at its September meeting, reassured by the uptrend in inflation, strong economic performance and longterm inflation expectations in line with its target. We expect it to extend its QE program in October until June 2017 as the Riksbank will try to match the ECB as well as because inflation, in our view, is set to disappoint. Monetary policy should help keep the EUR/SEK elevated. Flows. Corporates and institutions may see an increasing need to sell currencies after the summer season. Negative carry may come at a cost for some but we have a hard time seeing the SEK turning into a global funding currency. Valuation. EUR/SEK is high relative to fair value according to our short-term models. The krona is substantially undervalued based on medium- to long-term perspective fundamental models. Risks. Risk aversion would also typically weigh on the SEK. Upside surprises in GDP or inflation may send the krona higher than forecast. Stefan Mellin, Senior Analyst, mell@danskebank.se, Forecast: 9.40 (1M), 9.30 (3M), 9.30 (6M), 9.10 (12M) Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/SEK 1M 3M 6M 12M Forecast (pct'ile) 9.40 (18%) 9.30 (19%) 9.30 (29%) 9.10 (24%) Fwd. / Consensus 9.54 / / / / % confidence int / / / / % confidence int / / / / EUR/SEK Conclusion. Fundamentals and valuation are extremely favourable for the krona. Cyclical tailwinds have moderated, which has weighed on the SEK recently. Note however that in relative terms the growth outlook is still supportive of the downside. The Riksbank will match the ECB on QE extension as a way to counter any premature SEK appreciation. This is likely to keep EUR/SEK elevated for longer. We maintain our forecast profile, now at 9.40 in 1M, 9.30 in 3-6M and 9.10 in 12M. 6

7 EUR/SEK important issues to watch Re-introducing the tolerance interval Mr Ingves revealed that during the next couple of weeks the Riksbank will present a report on shifting the target variable and re-introduce a tolerance interval around 2%. The aim is to have a broad discussion before any decisions are made. We are sure it does not want to be perceived as becoming less ambitious, since it would be counterproductive. That said, it is not hard to imagine an opposite interpretation by the market. It seems to us that Mr Ingves has invited such a view when, in the latest RB Minutes, he said: [ ] it is impossible to control inflation so that it is always at exactly 2%. It will be perfectly sufficient if the Riksbank can push it up to around 2%. Reintroducing some kind of interval around 2% would facilitate discussions [ ]. Foreigners stopped selling Swedish govvies The fact that foreigners have stopped selling SEK bonds for the past couple of months it has been flat since January 2016 and as a share of total stock it is down to around 30% - is not only a potential problem for the Riksbank s QE program. It also means that one headwind for the SEK may be gone. Reduction of foreign ownership of Swedish government bonds arguably had a negative impact on the krona in the previous years (to the extent these holdings were unhedged). Chart 1: Riksbank expects stronger SEK Source: Macrobond Financial Chart 2: Foreign holdings of Swedish bonds Stefan Mellin, Senior Analyst, mell@danskebank.se, Source: Macrobond Financial, Danske Bank Markets 7

8 EUR/DKK steady at the strong end of the trading range FX. DN did not need to intervene in the FX market in August. EUR/DKK has settled in the range of since early August as the DKK appreciation pressure arising from tight DKK liquidity and concerns about the potential spillover to EUR from the UK vote to exit the EU have faded. Around the current level for EUR/DKK we do not expect DN to be active in the FX market. We forecast EUR/DKK to trade at on 1-12M. We see downside risk to our forecast from renewed concerns about the future of the EUR and look for DN to cap EUR/DKK downside around by selling DKK in FX intervention. Rates. We expect DN to keep the rate of interest on certificates of deposits unchanged at minus 0.65% on a 12M horizon. However, if the need to sell DKK in FX intervention accelerates, or if the ECB decides to cut its deposit rate further (not our main scenario), DN may opt to cut to minus 0.75% a level we still view as the lower bound for the key policy rate in Denmark. Liquidity. Tight excess liquidity in the DKK money market has eased on the back of DN selling DKK in FX intervention and buy backs of government bonds. With further buy backs in the pipeline, the liquidity situation is expected to ease further in the coming months. This should maintain moderate downward pressure on Danish money market fixings (CITA) while the impact on EUR/DKK FX forwards is relatively limited due to the simultaneous increase in EUR/DKK CCS basis. Forecast: (1M), (3M), (6M) and (12M) Source: Macrobond Financial, Danske Bank Markets Flows. 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 close to the strong end of the historical trading range on a 12M horizon. We see limited downside risk from the current level, as DN stands ready to intervene in the FX market to cap EUR/DKK downside. Jens Nærvig Pedersen, Senior Analyst, jenpe@danskebank.dk,

9 EUR/USD range-bound short-term, still higher longer term Growth. US GDP growth has slowed markedly to just around 1% q/q AR over the past three quarters and the ISM activity indicators are at the weakest level since 2010, suggesting that growth in Q3 may disappoint as well. In the euro area, GDP growth showed fairly solid GDP growth of 0.3% q/q in Q2 16 and initial survey indicators suggest fairly resilient economic conditions post the Brexit vote. Monetary policy. Weak US data has not supported the case for a Fed rate hike and we still believe that the Fed will wait until H1 17 to raise interest rates again. The market is pricing in just a 10% probability of a 25bp rate hike in September while the likelihood of a hike in December is viewed as 50/50 by the market. Meanwhile, the ECB maintained its monthly QE purchases of EUR80bn and still intends to end its purchases in March In our view, the ECB will eventually announce an extension of QE to September The extension announcement could occur in December when the ECB may also revise its inflation forecasts. We think it is unlikely that it will cut interest rates further. Flows. The market is short EUR/USD, according to IMM data, but not in stretched territory. As such, this increases the sensitivity of the cross to any impetus from relative rates. Valuation. Both our PPP and MEVA models suggest the mid- 1.20s are fundamentally justified and thus that the cross remains undervalued. Risks. Political risks in the eurozone and in the US are set to weigh on markets in coming months. However, this could be both EUR and USD negative. Thomas Harr, Global Head of FICC Research, thhar@danskebank.dk, Forecast: 1.12 (1M), 1.12 (3M), 1.14 (6M), 1.18 (12M) Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/USD 1M 3M 6M 12M Forecast (pct'ile) 1.12 (40%) 1.12 (40%) 1.14 (51%) 1.18 (64%) Fwd. / Consensus 1.12 / / / / % confidence int / / / / % confidence int / / / / 1.25 EUR/USD Conclusion. We keep our EUR/USD forecasts unchanged and still expect EUR/USD to continue to trade in the post-brexit range of in coming months. We target EUR/USD at 1.12 in 1-3M. While we believe that there will be some slowdown in the Eurozone in coming months, we still do not expect the ECB to cut rates. Political uncertainty is likely to increase as the US presidential elections are moving closer. However, political uncertainty could weigh on both the EUR and the USD and thus uncertainty is more likely to be source of increased volatility rather than a directional risk. Longer term, we maintain our long-held view that the undervaluation of the EUR and the wide eurozone-us current account differential are longer-term EUR positives. Hence, EUR/USD will reach 1.20 before it reaches 1.00, in our view. We target 1.14 in 6M and 1.18 in 12M. 9

10 EUR/USD important issues to watch Focus on US Election: Trump versus Clinton - The US election is moving closer and officially starting with the first presidential debate on 26 September. The election is due to take place on 8 November and, in the meantime, markets are set to focus on opinion polls and speculation. - Historically, Republican presidencies have coincided with a weaker USD, democratic presidencies have coincided with a stronger USD. One of the reasons is that US growth tend to be stronger under democratic presidencies. - We view a Trump win as negative for the USD given his protectionist focus and talk of debt cancellation. A Clinton win, which the market is expecting, will be slightly USD positive. Political risks also evident in the eurozone - In the eurozone, there are important political events over the coming year: (1) the Italian constitutional referendum in November; (2) the French presidential election in April/May 2017 and then the German election in September/October Meanwhile, it remains uncertain when the UK s negotiations with the EU following Brexit will begin. PM Theresa May has said that she will not trigger Article 50 before year-end at the earliest due to preparations. Q1 17 seems more likely. - We view European politics as a negative for the EUR but only modestly so, as long as it does not put the EU/euro project in too much doubt. The French election, in our view, is the biggest risk as the main opposition leader, Marine Le Pen, has stated that she will call an EU referendum if she becomes president. Clinton is still in the lead Source: Real Clear Politics, Danske Bank Markets Source: Bloomberg, Danske Bank Markets Thomas Harr, Global Head of FICC Research, thhar@danskebank.dk, National polls, 10-polls moving average 60 % of votes % of votes Clinton (D) Trump (R) EUR/USD and US presidents Republican presidencies are bearish USD Republican president Democratic president

11 EUR/GBP no Brexit recession but we still expect a BoE rate cut Growth. Soft economic indicators suggest that the UK rebounded in August after the initial deceleration in July, suggesting that the UK economy may avoid a Brexit recession. PMIs have rebounded sharply across sectors: the NIESR GDP estimate has been positive and consumer confidence is still at a relatively high level. As the economic data has been better than expected, we now expect quarterly GDP growth to stay positive during H2 16, i.e. we no longer expect a Brexit recession although the probability of a recession is still relatively high. However, the economy is still expected to slow markedly versus pre-referendum growth rates due to Brexit uncertainty. Monetary policy. As expected, the Bank of England (BoE) kept its monetary policy unchanged at the 15 September MPC meeting. It left the door open for more easing later this year if data meets expectations from August projections. However, the BoE signals that the probability has declined, as near-term indicators have been better than expected. We still expect a 15bp rate cut from 0.25% to 0.10% in November but it is a close call and will depend largely on how data comes out. There is only a 5bp BoE rate cut priced in for November; therefore, we think markets are too complacent about the probability of further easing. Flows. Investors have built up speculatively short GBP positions following the Brexit vote. Positioning looks increasingly stretched. Valuation. EUR/GBP is trading above the fair value estimates implied by our PPP model (0.77) and our MEVA model (0.755). Risks. Uncertainty about the future relationship between the UK and EU after the Brexit vote has increased uncertainty about nearterm FDI and portfolio flows into the UK, which along with the large current account deficit in the UK, implies a significant risk to GBP. Morten Helt, Senior Analyst, mohel@danskebank.dk, Forecast: 0.87(1M), 0.88 (3M), 0.92 (6M) and 0.90 (12M) Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/GBP 1M 3M 6M 12M Forecast (pct'ile) 0.87 (83%) 0.88 (78%) 0.92 (88%) 0.90 (74%) Fwd. / Consensus 0.85 / / / / % confidence int / / / / % confidence int / / / / 0.95 EUR/GBP Conclusion. We still expect EUR/GBP to trade higher in coming months. Our forecast of a weaker GBP is driven not only by BoE easing but also by the considerable imbalances in the UK economy, not least the significant current account deficit. In addition, net foreign debt accumulated through several years of current account deficits has made the GBP very fragile. The political uncertainty has declined for now but is lurking beneath the surface and will weigh on GBP when Article 50 is triggered. GBP has performed relatively well over the past month, as the economic data out of the UK have been better than expected. While data suggests that the UK may avoid recession in H2 16, we still expect the BoE to cut the Bank Rate by 15bp from 0.25% to 0.10% in November but it is a very close call and depends on data. The likelihood of more QE is low, however, and given the stronger-than-expected economic development post the UK s EU referendum, we have revised our 1-6M EUR/GBP forecast slightly lower to 0.87 (0.88) in 1M, 0.88 (0.90) in 3M and 0.92 (0.95) in 6M. 11

12 EUR/GBP important issues to watch Better-than-expected economic data means we no longer expect a Brexit recession As the economic data has been better than expected, we now expect quarterly GDP growth to stay positive during H2 16, i.e. we no longer expect a Brexit recession. We have lifted our GDP forecasts to 1.8% this year and 0.7% next year (previously 1.1% and -0.4%, respectively). While data suggests that the UK may avoid recession in H2 16, in our view this does not rule out further BoE easing, as it has indicated that it will cut rates again this year if its forecast for growth materialises (0.0%-0.1% q/q in Q3). Our revised forecast is more or less in line with the BoE s forecast and we still expect it to cut the Bank Rate 15bp from 0.25% to 0.10% in November but it is a very close call. The likelihood of more QE is low. Political uncertainty is lurking beneath the surface Political uncertainty has declined significantly after the crowning of Theresa May as new Prime Minister. May has said that Brexit means Brexit but that she will not trigger Article 50 before yearend at the earliest due to preparations. Q1 17 seems more likely. Recent comments from EU and UK leaders/ministers/officials suggest that the forthcoming negotiations will be tough. Although a deal is never sealed until just before deadline, we cannot rule out a hard Brexit scenario. So, overall, political uncertainty has declined for now but is lurking beneath the surface. Brexit uncertainty could hit sentiment, growth and financial markets again when Article 50 is triggered. Our new GDP forecast is in line with the BoE s Source: ONS, Bank of England, Danske Bank Markets Market pricing of BoE only a small chance of a further cut is priced in 0.50% 0.40% 0.30% 0.20% 0.10% 0.25% -1 GBP/OIS forward market % Sep16 Dec16 Mar17 Current Live Jun17 Sep17 Policy Rate Dec17 Morten Helt, Senior Analyst, mohel@danskebank.dk,

13 USD/JPY focus on BoJ assessment: policy adjustments but no easing Macro outlook. Q2 GDP was revised higher to 0.2% q/q from the initial estimate of 0.0% q/q and the PMI manufacturing business survey has bounced back in recent months, suggesting a stabilisation in the manufacturing sector. Moreover, with the government s fiscal stimulus package, which is expected to lift growth by about 0.3pp in 2016 and 0.9pp in 2017, the economy is expected to continue to grow above trend in the coming year. We forecast GDP growth of 0.6% in 2016 and 1.1% y/y in Monetary policy. All eyes will be on the comprehensive assessment due to be conducted by the Bank of Japan (BoJ) at the September monetary policy meeting for any indications of a change in the monetary policy framework and/or additional monetary easing. Governor Haruhiko Kuroda has been clear in saying that monetary policy tightening will not be discussed in relation to the assessment, but we do not expect the BoJ to ease monetary policy. However, we expect it to adjust its policy framework by abandoning its calendarbased communications on when it expects to reach the 2% target and instead pursue 2% inflation at the earliest possible stage. Moreover, we expect the BoJ to maintain its negative interest rate policy and keep the door open for additional rate cuts in the future while adopting a more flexible approach to its quantitative target for JGB purchases. 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. PPP is around 82, while our MEVA model suggests that is fundamentally justified. Risk. USD/JPY remains highly correlated with investors risk appetite. Non-commercial positioning is very long JPY, suggesting an increased correction risk towards a weaker JPY. Morten Helt, Senior Analyst, mohel@danskebank.dk, Forecasts: 101(1M), 102 (3M), 104(6M) and 104(12M) Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k USD/JPY 1M 3M 6M 12M Forecast (pct'ile) (34%) (45%) (56%) (55%) Fwd. / Consensus / / / / % confidence int / / / / % confidence int / / / / USD/JPY Conclusion. In our main scenario, we expect the BoJ to disappoint relative to market pricing at the 21 September meeting, suggesting that USD/JPY is likely to trade lower in the very near term. Given the market s low expectations for further Fed rate hikes, short-term valuations and positioning, we expect JPY appreciation pressure to lose momentum, and in the absence of a sharp deterioration in risk sentiment and/or substantial declines in crude oil prices, we do not expect USD/JPY to break significantly below 100. We target 101 in 1M and 102 in 3M. On a 3-12M horizon, we see USD/JPY in rage of On the one side, the prospect of a monetary policy surprise (either from the BoJ or the Fed) is low and while underlying support for JPY stemming from fundamental flows is likely to remain intact, we see the effects diminishing as the yen is no longer undervalued. Moreover, we expect the market to continue to price in a probability of a BoJ rate cut in the future, which will remain a supporting factor for the cross. We target USD/JPY at 104 in 6-12M. 13

14 USD/JPY important issues to watch All eyes on the BoJ s comprehensive assessment The decision to conduct a comprehensive assessment was announced in the July statement, as the BoJ sees heightened uncertainty over the inflation outlook. The assessment will, according to the BoJ, be conducted with a view to achieving the price stability target of 2% percent at the earliest possible time, suggesting that the BoJ is not about the change its monetary policy target. Communication from both BoJ Governor Haruhiko Kuroda and Deputy Governor Hiroshi Nakaso suggests that the BoJ s policy review will focus mainly on two issues: (1) factors that have potentially hampered achievement of the 2% price stability and (2) the cost and benefits of negative interest rates. Moreover, comments from various BoJ members, and not least research discussion papers released since the July meeting, suggest that the shape of the JGB yield curve also might be an important element of the assessment. The yield curve has bull flattened significantly since the introduction of negative interest rates. Market expects BoJ to take action but rate cut expectations are low According to the latest survey from JCER (Japan Centre of Economic Research) 30 out of the 50 (60%) analysts that responded to the survey expect the BoJ to ease in September. Among the analysts that expect more BoJ easing this month, most expect the BoJ to buy other assets, while more than half of the analysts that responded expect the BoJ to cut interest rates. Pricing in the Japanese money market implies only a slight probability of a rate cut in September, while the overnight interest rate is priced to fall to -0.25% in 12 months time. The long end of the JGB yield curve has steepened substantially over the past few weeks suggesting that some sort of measure to target the shape of the curve has been priced in. Morten Helt, Senior Analyst, mohel@danskebank.dk, Rate cut expectations are low Pricing JPY-OIS 1m swap -0.10% -0.15% -0.20% -0.25% -0.30% -0.35% -0.40% -0.45% Jul16 Jan17 Jul17 Jan18 Jul18 Jan19 Jul19 Jan20 Current live 27-Jul-16 JGB yield curve has steepened recently Source: E-Views, Bloomberg, Danske Bank Markets 14

15 EUR/CHF long-term fundamentals remain positive Growth. The Swiss economy expanded 0.6% q/q in Q2 and August s manufacturing PMI recovered to 51.0, suggesting that the Swiss economy is holding up reasonably well and has been left relatively unscathed by the UK s vote to leave the EU. The Swiss economy is slowly crawling out of the doldrums of deflation. CPI inflation was -0.1% y/y in August up from - 1.4% at the end of Monetary policy. The Swiss National Bank (SNB) has continued to intervene substantially in the FX market post the Brexit vote in order to curb CHF appreciation pressure. The SNB s currency reserve rose to a record high in August at CHF627bn. As the ECB has moved the fingers from the rate cut button, the pressure on CHF from relative rates has eased. We expect the SNB to keep both the Libor target midpoint and the sight deposit rate at minus 0.75% for the foreseeable future. We expect the SNB to continue to use intervention as a first line of defence should the franc appreciate further. Flows. Positioning remains broadly neutral on the CHF and is less stretched on EUR shorts than at the start of the year. Valuation. Both our PPP and our MEVA model suggest that a level of for EUR/CHF is fundamentally justified; hence, the cross is undervalued on both measures. Risks. The SNB s commitment to prevent sustained CHF appreciation has limited the downside risks to EUR/CHF. However, the SNB has no specific target for EUR/CHF, but focuses more on a trade-weighted CHF measure. Forecast: 1.09(1M), 1.09 (3M), 1.12 (6M) and 1.15 (12M) EUR/CHF 1.00 Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k EUR/CHF 1M 3M 6M 12M Forecast (pct'ile) 1.09 (31%) 1.09 (37%) 1.12 (79%) 1.15 (86%) Fwd. / Consensus 1.09 / / / / % confidence int / / / / % confidence int / / / / 1.15 Conclusion. EUR/CHF has been trading in the range over the summer as the SNB has capped CHF appreciation via FX interventions. We expect the SNB to remain active in the FX market and still expect EUR/CHF to remain range bound in the coming months targeting the cross at 1.09 in 1M and 3M. Longer term, we continue to expect fundamentals to support a higher EUR/CHF and keep our 6M and 12M forecasts unchanged at 1.12 and 1.15, respectively. Jens Nærvig Pedersen, Senior Analyst, jenpe@danskebank.dk,

16 USD/CAD BoC to stay on hold despite twist in language Growth. Data releases have been very mixed over the last month as the economy shrugs of the devastating Alberta wildfires. While the latest labour market reports and the quarterly GDP release have disappointed, the June GDP release suggested a decent rebound going into Q3. Also recent data for merchandise exports were encouraging after a dismal Q2 but the latest developments in the US economy (by far the most important export destination) are worrying. Finally, core inflation remains stable around 2% with inflation expectations having moved slightly higher over the last month. Monetary policy. As widely expected, the Bank of Canada kept the policy rate unchanged at 0.5% at the September meeting. Surprisingly, the BoC twisted its language on the balance of risk for inflation from roughly balanced (in July) to tilted somewhat to the downside. Markets currently assign a roughly 20% probability of an additional 25bp rate cut in 12M. We maintain the call that the Bank of Canada will leave rates unchanged over the coming year. Flows. According to IMM data, speculative CAD positioning is in neutral territory. Valuation. Our MEVA estimate for USD/CAD is around 1.23, 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 at a substantial discount to WTI. Risks. In the short-term the biggest risk factor to our forecasts is a global risk-off event. Also the Bank of Canada is set to renew its monetary policy target at end Kristoffer Kjær Lomholt, Analyst, klom@danskebank.dk, Forecast: 1.32 (1M), 1.30 (3M), 1.28 (6M) and 1.25 (12M) Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k USD/CAD 1M 3M 6M 12M Forecast (pct'ile) 1.32 (53%) 1.30 (40%) 1.28 (35%) 1.25 (32%) Fwd. / Consensus 1.32 / / / / % confidence int / / / / % confidence int / / / / 1.45 Conclusion USD/CAD We expect the fundamentally undervalued loonie to appreciate gradually over the coming year on the back of valuation, a gradually higher oil price and markets repricing Bank of Canada monetary policy. We lift our USD/CAD forecasts to 1.32 in 1M (from 1.30), 1.30 in 3M (1.29), 1.28 in 6M (1.27) but leave our 12M forecast of 1.25 unchanged. 16

17 AUD/USD range trading for now, lower eventually Growth. The Australian economy continues to perform well in a global comparison. In Q2, the economy expanded 0.5% from the previous quarter and 3.3% from the previous year. Growth was slightly lower than consensus expected, but on the other hand a little higher than central bank (RBA) forecasts. In the mining sector, the worst seems to be behind and higher prices for commodity exports are supporting terms of trade. Still, growth is expected to slow somewhat going forward. RBA forecasts growth to be around the % range for the remaining part of the year. Growth is still driven by domestic demand and exports, whereas business investment continues to decline. Monetary policy. The RBA kept the cash rate unchanged in September after cutting to a record low of 1.50% in August. The statement was rather boring and basically repeated the message from the August meeting. After the September meeting, RBA speakers have been pretty upbeat about the economy. Continued strong growth in Q2 together with recent AUD weakness make further rate cuts less likely at this point. However, as dwelling prices are not rising as fast as they were a year ago, the RBA would not hesitate to cut rates further if the growth outlook deteriorates or AUD appreciates significantly. The next inflation release is not until 26 October and the RBA is expected to stay sidelined for now, watching the effect of its latest rate cut working its way through the economy. Flows. According to CFTC data, speculative net long positions are still at a relatively high level. Valuation. Fundamentally, AUD/USD is still overvalued, with our PPP and MEVA models having 0.72 and 0.71 as fair, respectively. Risks. Were the Federal Reserve to surprise the markets and hike rates this year, USD could appreciate vs. AUD faster than we forecast. On the other hand. a faster-than-expected recovery in commodity prices could lead to AUD strength. However, as a strong AUD is not something that RBA desires, the upside is capped by fear of more aggressive RBA easing. Minna Kuusisto, Analyst, mkuu@danskebank.com, Forecast: 0.76 (1M), 0.74 (3M), 0.73 (6M) and 0.72 (12M) AUD/USD 0.60 Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k AUD/USD 1M 3M 6M 12M Forecast (pct'ile) 0.76 (70%) 0.74 (41%) 0.73 (37%) 0.72 (37%) Fwd. / Consensus 0.75 / / / / % confidence int / / / / % confidence int / / / / 0.83 Conclusion. Global risk-off on one hand, and fear of a Fed hike on the other, have fed USD strength and weighed on AUD. After our previous update, AUD has depreciated more than 3% vs. USD as commodity prices have also dropped. Weaker AUD brings relief to RBA and the central bank could stay sidelined for now. Nevertheless, it is obvious that RBA is less worried about overheating of the housing market than it was before, so should need be, it would not hesitate to cut rates further. The market is pricing 80% probability of a cut during the next 12M however, only a 30% probability of a cut this year. As AUD is still overvalued from a fundamental perspective, we continue to expect a gradual decline in AUD/USD exchange rate over forecast horizon and keep our forecast unchanged. Despite of our positive view on EM in general, we see central bank divergence as the main driver in AUD/NZD, supporting gradual AUD depreciation. However, as we do not expect the Fed to hike this year and the RBA is in no hurry to cut, we see potential for a temporary rebound and range-trading once the risk market sell-off abates. 17

18 NZD/USD central bank divergence set to push NZD lower next year Growth. Economic growth in Q2 was stronger than the central bank (RBNZ) had projected, as the economy expanded 0.9% (0.8% expected) from the previous quarter and 3.6% from the previous year. However, weak global conditions and a low interest rate environment continue to place upward pressure on NZD, which despite the recent depreciation, is 2% stronger than the central bank projected in August in trade-weighted terms. Inflation was only 0.4% in Q2 and the high exchange rate is pressing both exporters and import-competing sectors. Domestically, growth is still driven by strong net migration, construction, tourism and monetary policy easing and dampened by low dairy prices. House price inflation remains a concern and the central bank recently introduced new measures to curb overheating of the housing market. Monetary policy. In August, the RBNZ cut the cash rate by 25bp to a record low of 2.0%. The central bank was more dovish than before, saying its current projections indicate further policy easing will be required. In our view, the recent NZD depreciation sparked by the global risk market sell-off should give RBNZ some time to evaluate the impact of its latest measures before resorting to further cuts. Nevertheless, as inflation is expected to weaken in Q3 and to stay low for coming quarters, we do not think we have seen the last cut from RBNZ yet. We expect a dovish statement in September, which could be followed by a cut in November if the Q3 inflation print disappoints. Currently, the market is pricing in a c probability of a cut this year and a c.80% probability of a cut in Q1 16. Valuation. Fundamentally, NZD/USD looks significantly overvalued. Our MEVA and PPP models have 0.65 and 0.64 as fair, respectively. Risks. Were the Federal Reserve to surprise the markets and hike rates this year, USD could appreciate versus the NZD faster than we forecast. On the other hand. a faster-than-expected recovery in commodity prices and more procrastination from the Fed could keep NZD strength in check. However, as the RBNZ is eager to curb NZD strength, we see risk skewed to the downside in NZD/USD. Forecast: 0.74 (1M), 0.72 (3M), 0.70 (6M) and 0.69 (12M) Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17 May-17 Aug-17 75% conf. int. 50% conf.int. Forward Danske fcst Consensus fcst k NZD/USD 1M 3M 6M 12M Forecast (pct'ile) 0.74 (69%) 0.72 (43%) 0.70 (33%) 0.69 (35%) Fwd. / Consensus 0.73 / / / / % confidence int / / / / % confidence int / / / / 0.81 NZD/USD Conclusion. The September sell-off and NZD weakness has bought RBNZ some time to see how economy responds to its latest easing measure. However, as inflation is expected to stay low, we expect RBNZ to cut rates again by Q1 17 at the latest. Despite of our positive view on EM in general, we expect only a gradual recovery in commodity prices and we still expect the Fed to continue its hiking cycle next year, which dampens the relative attractiveness of NZD. We have changed our forecast slightly as we see monetary policy divergence gradually driving NZD lower over our forecast horizon. However, in the short term, as we see the current risk market sell-off as temporary and do not believe in a Fed hike this year, we expect to see a temporary rebound in NZD once uncertainty fades. We see NZD/USD at 0.74 in 1M, 0.72 in 3M, 0.70 in 6M and 0.69 in 12M. Minna Kuusisto, Analyst, mkuu@danskebank.com,

19 USD/CNY depreciation trend set to continue in coming years Monetary policy. Chinese growth recovered in Q2 driven by the construction sector and a moderate recovery in exports. However, a decline in credit growth recently suggests that the boost from infrastructure spending is fading and growth is likely to lose some momentum again in We expect the People s Bank of China (PBoC) to be sidelined for the rest of 2016 as China has signalled it will turn to fiscal policy for more policy support if needed to keep growth up. However, in 2017 we expect renewed monetary easing as economic momentum fades again. 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 managed against a basket of currencies rather than the USD. China aims for a stable currency around the equilibrium level but has not been explicit about the extent of fluctuation it will tolerate. The CNY is still labelled as stable by the PBoC despite a 10% depreciation from the peak in We believe China will quietly aim for a continued gradual weakening of CNY but step in if the move becomes too fast to secure financial stability. Capital outflows could pick up again if the debt concern intensifies when growth slows down and debt continues to grow. 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 close to 3% of GDP. Risks. There is a risk that the CNY could depreciate faster in the medium term if growth slows down and/or debt worries create a new confidence crisis. Allan von Mehren, Chief Analyst, alvo@danskebank.com, Forecast: 6.70 (1M) 6.75 (3M), 6.85 (6M) and 7.10 (12M) Source: Macrobond Financial, Danske Bank Markets Conclusion. We look for CNY to weaken gradually against the USD as the Fed resumes raising rates and China resumes easing monetary policy in However, we do not expect a bigger devaluation as the CNY is not overvalued and China wants stability around its currency. Against EUR, we expect CNY to depreciate close to 10% +12M. The CNH-CNY spread has been quite stable after calm was restored in February. We expect the spread to stay at around zero or slightly above throughout the forecast horizon. Hence, basis risk in hedging CNY exposure through CNH is expected to be limited. If the spread moves out, the PBoC is likely to use higher CNH money market rates (by draining liquidity) to pull it down close to zero again. 19

20 USD/RUB becoming boring Growth. According to the confirmed preliminary data, Russia s GDP shrank 0.6% y/y in Q2 16 versus a 1.2% y/y fall a quarter earlier as details by economic activity have been published. Agriculture expanded 2% y/y, manufacturing, mining and quarrying by 0.3% y/y while construction shrank 9.5% y/y, wholesale and retail fell 1.2%. In January-July 2016, the economy shrank 0.9% y/y, contracting 0.1% m/m S.A. in July as manufacturing and wholesales growth was negative. We keep our 2016 GDP growth forecast at -0.6% y/y (given the Brent year average at USD48.6/bl) and 2017 GDP growth at 1.2% y/y. Monetary policy. On 29 July, Russia s central bank (the CBR) kept its key rate at 10.5% as consensus and we expected. The main reasons given by the central bank for keeping the key rate unchanged were the stalling decline in inflation expectations, the CBR s comfortable stance on an upcoming economic recovery and its uncertainty about reaching its inflation target by the end of 2017 (4% y/y). We expect the CBR to cut the key rate by 50bp on 16 September, as disinflation has resumed and inflation expectations are falling further. We expect the total cut to be 100bp in 2016 on gradual monetary easing. Flows. Over the past eight months, capital outflows slowed to USD9.9bn, while in August capital inflow exceeded outflows by USD1bn, which is supporting the RUB. Valuation. Given an 8.3% m/m increase in the 30-day average of the Brent price, the RUB 30-day average even fell 1.4% m/m as RUB s and oil s divergence went on. As the RUB is diverging slightly from the oil price, the USD/RUB pair is hovering around its fair value. Vladimir Miklashevsky, Senior Economist/Trading Desk Strategist, vlmi@danskebank.com, Forecast: (1M), (3M), (6M) and (12M) Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 1M 3M 6M 12M Forecast Fwd. / Consensus / / / / USD/RUB Forward Forecast Risks. The geopolitical tensions surrounding the Ukraine crisis are again out of the main news but any serious escalation could weaken the RUB. Yet, markets have become less sensitive to geopolitics than they were back in A change in the Fed s dovish monetary stance in H2 16 would weigh on the RUB further. Conclusion. Russia s currency profited from the post-brexit emerging markets rally, diverging from the crude price. We continue to be moderately bullish on the RUB in the long term. However, the political risk and possible intensification of Western sanctions should be constantly kept in mind, as possible black swan events could prevail over fundamentals. 20