US dollar

1-3 Month Outlook –“Continued moderation”

The US economic outlook has not changed that much in the past month, at least not in our view. August payrolls came in line with expectations, the unemployment rate ticking back down to 4.2%. Job growth has been slowing (~115k/month over the last 3m, down from 147K in Q2 and 267K in Q1) but at a pace in line with the FOMC narrative of “continued moderation”. They cite healthy aggregate household finances and firm services activity, albeit with downside risks to employment that they are watching closely. But market sentiment seems less sanguine. Analyst forecasts may be unchanged (the perceived risk of a US recession in the next 12m is just 30% – its lowest level in more than two years).
But market sentiment on USD has shifted noticeably. Figure 1 shows aggregate USD positioning from our monitor. We have flipped from a net long position that had been in place all year to the shortest aggregate USD position since early 2021. Recall the last time markets turned net short USD in Dec/Jan, we were priced for -125bps by end-2024. That proved hugely premature and yet we are back to pricing –
100bps now, with a 20% chance of the cycle starting with 50bps in September (RBC -25bps). It is hard to see investors piling back into G10 carry (long USD/JPY, long USD/CHF, etc) the way they did in H1, when it was still possible the next Fed move would be a hike, and holding high-carry USD in a low vol environment made sense as a strategy. But if the US is not heading into imminent recession, it is also hard to see a good reason to pile into short USD in the next 1-3m, and in fact USD has already retraced from its lows, with positioning also moderating (red circle, Fig 1). Our Fed call is now -75bps in 2024 with -50bp in 2025. The problem for USD is that even if the Fed goes slow in 2024, the market narrative of a Fed ‘behind the curve’ prevents 2025 yields moving much higher which limits support to USD. We have
nudged down our USD forecasts to factor in weaker sentiment but stop short from turning into USD bears unless we see clearer signs of recession.

6-12 Month Outlook – Fiscal easing either way?

Last month we noted polls put Trump and Harris in a statistical tie, now bookies odds do the same (Figure 2). Policy details from Harris have been sparse but as they emerge, point to a fair degree of fiscal easing, meaning whoever wins, fiscal policy is likely to remain supportive. As discussed before, the scale of the US’ procyclical budget deficit causes concern longer-term but as long as the private sector runs a surplus, the budget deficit can be financed without turning it into a bearish USD story. Tariffs remain an
upside USD risk.

Euro

1-3 Month Outlook – Short-lived momentum trade

August saw the largest monthly gain for EUR/USD since November 2023. At its peak, EUR/USD broke above 1.12, a level not seen since last summer when US recession talk was skyrocketing and EUR/USD reached 1.1276. In many ways, last month’s move was the same. It was driven not by positive news out for Europe but more by a reassessment of US exceptionalism. The July payrolls report on August 2
kickstarted the move, but it extended further as 1.10 broke, long-term short positions were unwound and momentum players were drawn in. Economists’ forecasts have not actually shifted as much as price action might suggest. The consensus probability of the Euro area and US hitting recession in the next 12m is equal at 30% (both at or near the lows). Consensus growth forecasts still have the US outperforming the Euro area in 2025, albeit by a much smaller magnitude than 2024 or 2023 (Figure 1). Granted the Fed is set to start cutting rates this month, with what we expect will be a 25bps move, but the ECB is just as likely to continue, also with a 25bps move. Our US team recently revised their forecast to pencil in a third Fed cut this year in November, but even if the ECB skips that meeting, the two central banks would still match off with -75bps this year, maintaining the rate differential that already existed. In the past week, the long EUR momentum trade has already run out of steam, and cross/EUR selling has opportunistically resumed. PMIs point to ongoing weakness in European manufacturing and while services are expanding, Q2 growth was just 0.2%q/q. We have nudged up our end-Q3 EUR/USD forecast as we think it may take longer for markets to abandon the end-to-US-exceptionalism trade, but have left
end-Q4 unchanged.

6-12 Month Outlook – Longer-term upward bias

On a longer horizon, the main upside risk is a US recession. We think EUR/USD could hit 1.20 in that scenario. We know that is a pretty off-consensus view as most people we speak to argue the USD smile should send USD higher in the event of any recession, US or EZ-based. We discuss the hedging
dynamic which explains why we disagree here. European investors are also holding a huge stock of US equities (Fig 2), We think EUR is under appreciated as a winner in this scenario. The main downside risk to EUR/USD is still a Trump victory and more aggressive tariffs, though the probability of that outcome is much less certain in investors’ minds than it was before Biden dropped out in July. We have left our long-term forecasts unchanged, though would push them down again if Trump were to win and/or US activity were to reaccelerate into 2025.

Sterling

1-3 Month Outlook – One more BoE cut this year

In August, GBP was one of the relative under performers in G10, but most of this underperformance happened at the start of the month, with EUR/GBP re-testing the key ~0.8400 level and GBP/USD reaching a new YTD high of 1.3266 by the end of the month. This quick reversal was a function of the
external backdrop turning more benign, while the relative rate dynamics were mixed for GBP vs the rest of G10. Since the BoE delivered the first rate cut of the cycle on August 1, July CPI y/y surprised to the downside, with core CPI decelerating from 3.5% to 3.3% and services CPI notably decelerating from 5.7% to 5.2%, allowing space for further BoE cuts. On the growth front, ‘flash’ Q2 GDP was in line
with expectations (see here). Our UK economist expects growth to slow down in this half of the year and sees Q3 GDP growth coming in at 0.3% q/q though the risk is tilted to the upside (BoE August MPR: 0.4% q/q). The manufacturing and services PMIs remained firmly in expansionary territory in
August, supporting this upside risk to growth. As for the labor market, the latest report from August 13th showed a surprising 0.2pp fall in the unemployment rate to 4.2% and employment gained 97k 3m/3m, but more importantly, wage growth continued to slow. Looking ahead, our economist continues to see just one more cut this year in November (mkt: ~ -45bp by year-end). Although this poses an upside risk to GBP, the 0.8400 level has been a strong support for EUR/GBP, and more importantly, the market’s
long GBP vs USD & EUR positioning leaves GBP vulnerable. Thus, we are keeping our slight uptrend for EUR/GBP intact. Outside of monetary policy, the market will be watching the
Autumn Budget on October 30th.

6-12 Month Outlook – Uptrend in EUR/GBP

We are keeping our medium-term EUR/GBP profileunchanged. Although our expectation for a shallow BoE rate cutting cycle suggests markets are overpricing rate cuts over the next 12m, and we expect the UK will retain a yield advantage in G10, we think GBP faces more downside than upside risk, as the most recent market rout showed in early August. This risk reflects the market’s long GBP positioning (Figure 1) and GBP remaining overvalued on a real effective exchange rate basis from a historical perspective (see Figure 2). A currency being overvalued does not automatically mean that the currency will fall, but if any concerns about the growth outlook or fiscal credibility rise or there is an
external risk-off shock, then GBP is vulnerable.

Australian Dollar

1-3 Month Outlook – Drag from cross-currents

The Aussie dollar has been range-bound year-to-date, whether against USD or EUR. Australia’s headline and core inflation remains stubbornly elevated, keeping the RBA war of easing policy. At the same time, China growth concerns have weighed on iron ore prices that have fallen to the lowest level in over a year. In general, Australia’s exports have fluctuated lower year-to-date, but the labour market remains robust. The market has persistently overlooked the RBA’s “hawkish hold” message by anticipating some rate cuts before year- end. The Aussie dollar also retains a clear negative correlation to the MSCI World Index, indicating that it remains a relatively pro-risk currency. Hence, the recent global equity wobbles have helped check AUD gains despite the US dollar’s correction. Nonetheless, AUD-USD rate differentials point to growing upside pressure on AUD/USD. We are also forecasting the start of RBA policy easing only in Q2 2025, well after the Fed starts its easing cycle this month. We do think that the market is pricing in too many Fed cuts this year, and this should drag on AUD/USD as those expectations are partly unwound, along with China demand remaining sluggish. Furthermore, downside pressures on the
Aussie could escalate if the recent global equity market wobbles were to worsen. So AUD/USD spot is likely to stay range-bound near-term.

6-12 Month Outlook – Positive policy divergence

Australia’s external balance has improved structurally in recent years, turning it into a persistent current account surplus country. It is also no longer an obviously “high carry” currency relative to other G10 currencies. Nonetheless, AUD remains sensitive to global risk sentiment, and it is difficult to see this changing in the coming year. The RBA’s relative hawkishness compared to other major central banks should help support the Aussie. The main fundamental check on the currency is China’s economic
malaise, which is likely to extend into 2025, if not beyond. Still, monetary policy divergence argues for likely AUD outperformance against EUR and USD over the next year.

Japanese Yen

1-3 Month Outlook – If the Fed cuts faster, JPY has
more to gain than any other currency…

As we go to press, USD/JPY is almost exactly where it was atthe time of our last Currency Report Card, which was also published just after the last payrolls report (Aug 2). We are not far from the lows for the year, with the technically bearish outlook very much intact. The question most people are asking themselves is how far has the unwind in USD/JPY gone? It is impossible to know with certainty but we expect data on lifers’ semi-annual hedge ratios, which will start coming out later this month, to show those ratios still running at historically low levels. They are likely to remain that way, even with the BoJ hiking and the Fed starting to cut later this month. Speculative flow has been faster to unwind (Figure 1 from the RBC positioning monitor) but incoming flows into long USD/JPY have resumed. The result
is a disconnect between USD positioning against JPY and vs. all other G10 currencies, including the other low-yielding CHF. This is a key reason we like CHF/JPY lower. It is not our call, but if the Fed is forced to cut faster than priced, JPY stands to gain the most. If the Fed is slower to cut, long USD/CHF positioning has more room to rebuild than USD/JPY. The BoJ now has two hikes under its belt (though only +35bps in total) and while the second of the two generated a dis ordinate amount of excitement, coming in a week of very soft US data and appearing to trigger a broader risk sell-off, we think that was exaggerated by a VaR shock across asset classes and how heavily crowded long USD/JPY was in late July. That is unlikely to be repeated, with net longs now sitting at 40%.

6-12 Month Outlook – Hedges start to look attractive

The yield differential between the US and Japan has a long way to go to make hedging really economic again, so despite our preference for long JPY vs CHF, we expect USD/JPY to remain above 140 throughout our forecast horizon. But if we are wrong about the US terminal rate for this cycle being
above 4%, and the forward curve turns out to be closer to the truth, hedges will start to look attractive again, even for USD-denominated assets. Note also how the implied yield on Japan’s overseas bond holdings is creeping higher (Fig 2), as investors move further out the credit curve, making the
hurdle lower for domestic Japanese investors to turn into USD/JPY sellers. For now we have left our end-2025 target unchanged after making revisions last month, but have flattened the peak.

Swiss Franc

1-3 Month Outlook – Too quick to turn long CHF

CHF seems to be the prime beneficiary of the shift in US economic prospects coupled with a total unwind of the long USD/CHF carry trade that was so popular in H1. As we go to press, USD/CHF has traded below 0.84 for the first time since January – a level it has very rarely traded below over
the last century, while our positioning monitor shows USD/CHF turning net short, also for the first time since January. Technically there is a medium-term bearish backdrop in place, with resistance at 0.8538 and 0.8679. A close below 0.8400 (so far we have only seen an intraday break) would add to bearish price momentum, targeting the 2023 low at 0.8333. Prices need to return above a trendline at 0.8867 to nullify the downtrend. Fundamentally though, it is hard to argue in favour of long CHF at these levels. Even if one thinks the US is about to hit recession, short USD/JPY looks like a much better way to play it . In Switzerland, we have a central bank that is set to cut rates again this month, taking them to just 1%, likely followed by another 25bps cut in December and further cuts next year. Both headline and core inflation are sitting at just 1.1% and so far Q3 is undershooting the SNB’s last forecast from June.
The SNB’s revised inflation outlook is likely to reinforce its determination to prevent excessive currency strength from pushing inflation lower still. Last month’s bearish technical outlook for USD/CHF proved to be more accurate than our long-term bias for CHF to top out and start retracing. But one of our favourite trades right now is short CHF/JPY – positioning, relative central bank stances and valuations are
all supportive while it is relatively neutral to US data.

6-12 Month Outlook – SNB leaning against strength

The carry trade may be far less popular now than it was in H1, but unless global growth deteriorates, it is not clear why someone would want to hold onto long CHF over a 6-12m horizon. By mid-2025, the SNB is likely to have cut rates to well below 1%. In any kind of carry-friendly environment, CHF will be a persistent underperformer. Long CHF positions, particularly against USD, do not typically last for
more than a few weeks at a time (again absent a US recession). In the event of a US recession, as noted above, we think JPY has more to gain, both starting from a position of undervaluation and because the SNB is more likely to stand in the way of what it perceives to be excessive CHF strength that once again threatens to import deflation. We have smoothed out our CHF profile but left the end-2024
and end-2025 points unchanged.

Canadian Dollar

1-3 Month Outlook – No pause? Risk of -50bp?

In August, USD/CAD finally broke below key 1.3590 support following Fed Chair Powell’s speech in Jackson Hole, with the pair trading to a high of 1.3946 and a low of 1.3441 throughout the month. As we go to press post-double payrolls, USD/CAD continues to hold above the ~1.3413/1.3450 support area we have been watching. On September 4, the BoC delivered a third consecutive 25bp rate cut in line with expectations. They kept the door open to more cuts and repeated that they will make “decisions
one at a time” . RBC’s base case is for the BoC to continue to cut in 25bp increments, with one in October, a pause in December & January, and then a total of 100bps of cuts in 2025. But we think the September meeting has lowered the hurdle for the BoC to cut rates without pausing and even deliver -50bp at one of the coming meetings (October more likely than later). The BoC’s growth forecasts for H2 2024 look optimistic vs our & consensus expectations. Although it is still too early to tell, the ‘flash’ July GDP estimate suggests Q3 has started off on a soft tone. In fact, the Bank already acknowledged in September that there is downside risk to their H2 2024 growth profile (“Recent indicators
suggest there is some downside risk to this pickup” and “we need to increasingly guard against the risk that the economy is too weak and inflation falls too much”). Even though markets are already pricing ~
-65bp for the BoC, if the Fed cuts -75bps (RBC’s new forecast), undershooting the -112bps currently priced by year-end, that still points to USD/CAD drifting higher from here, with our new end-Q3
and end-Q4 forecasts at 1.3650 and 1.3750 respectively (prior 1.3850 & 1.4000). The pair could push a lot higher if US equities continue to sell off.

6-12 Month Outlook – Lowering USD/CAD profile

RBC Economics sees the BoC cutting rates by a total of 125bp between the next meeting and next year (mkt: – 158bp by end-2025), while our US rates team sees a total of -125bp for the Fed, with the terminal rate being reached in Q1 2025 (mkt: -233bp by end-2025). These relative rate dynamics still point to some upside risk to USD/CAD into early next year. But moves above 1.40 in USD/CAD are likely to be met with significant hedger selling interest. Downside US economic surprises are generally speaking a downside risk to USD, but unsurprisingly that holds less for CAD. Historically it has typically struggled to perform in the face of a US recession and we expect that to still hold.