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US dollar a safe haven currency

Political uncertainty a positive factor for the US dollar

The initial selling squall in the Turkish lira in mid August generated massive uncertainty in financial markets. This led to a flight into safe haven assets, including the US dollar, which advanced strongly. The euro briefly dipped to 1.13 vs. the dollar before tensions eased, allowing the euro to bounce back to the 1.17 USD level. By contrast, the recent renewed sell-off in the Turkish lira (and the Argentine peso) didn’t have much impact on EURUSD anymore.

Political issues are likely to remain a persistently recurring factor driving financial markets until well into autumn. Uncertainty is surrounding Italy’s budget and the associated outlook for public debt, the Brexit negotiations, the ongoing investigations around president Trump, as well as the mid-term elections in November. These events could repeatedly trigger flight into the US dollar. All of this is happening against the background of interest rate trends which continue to favor the US dollar. We expect two further rate hikes in the US this year, while the interest rate landscape in the euro zone (on the short end) should only begin to shift after the summer of 2019. Our expectation remains that the euro should reach its weakest levels against the dollar by the end of the year. The euro should only strengthen again next year, once a peak in US interest rates and at the same time an increase in euro area interest rates are at least beginning to come into view.

JPY – BoJ strengthens commitment to low interest rate policy

After the markets had digested the renewed wave of uncertainty triggered by the dispute between the US and Turkey, the yen began to weaken against the euro from mid August and currently trades at around 130.5 again, close to the upper boundary of its recent trading range. From the perspective of investors, a muted trend in Japanese inflation relative to the euro zone continues to lend support to the yen against the euro since April (based on real interest rate differentials). Based on the inflation forecasts of BoJ and ECB this shouldn’t change in 2019 either. Moreover, the trend in producer prices in Japan and the euro zone has also moderately supported the yen against the euro since the beginning of the year. In view of the disappointing developments on the inflation front (+0.8% y/y in July), the BoJ explicitly announced at its last meeting that it intends to maintain the current low level of interest rates for a long time to come. Negative deposit rates and control of the yield curve (with the goal of keeping yields on 10-year JGBs at a level of 0%) remain in place. With this step the BoJ’s policy bias is increasingly drifting apart from that of the ECB.

We continue to forecast a gradual increase in the yields on long term German government bonds, hence the yen should be expected to weaken against the euro in coming months – provided the BoJ does not tighten monetary policy. From a technical perspective the euro-yen cross currently trades at the upper end of a rather wide trading range from 126 to 132. The Bloomberg analyst consensus is calling for EURJPY to trade at 129 by Q4 2018. However, as the global environment remains quite tense on account of numerous trouble spots (US sanctions against various countries, trade disputes, etc.), a rapid appreciation of the yen due to its status as a safe haven currency is possible at any time.

EURCHF – Uncertain autumn clouds outlook

In view of a global environment characterized by persistent uncertainty (US sanctions against various countries as well as trade disputes), exacerbated by political risks in the euro zone (due to Italy’s government), appreciation pressure on the Swiss franc remains strong. In this environment solid economic fundamental data in the euro zone are becoming less important from the perspective of investors. Unfortunately a number of issues remain to be faced in the autumn, which in a worst case scenario could boost upward pressure on the Swiss franc even further. For one thing the Italian government is expected to present its 2019 draft budget at the end of September. Overly radical proposals or partial disregard of European budget targets would increase uncertainty among investors further and could subsequently lead to growing pressure on the Swiss franc. Moreover, if the Brexit negotiations were to fail (the ultimate outcome will probably only become clear by November or December) pressure on the Swiss franc could grow as well. In this environment the unchanged willingness of the SNB to intervene in foreign exchange markets gains in importance. It remains to be seen how the SNB will respond to the changed market environment on occasion of its next meeting on 18 September.

A sustainable easing of pressures on the Swiss franc to appreciate against the euro would in our opinion require a stabilization of the situation in Turkey, as investors see the latter as a trouble spot threatening European banks, while Italy’s government would have to present a responsible 2019 draft budget. We believe economic fundamentals (which would favor a weakening of the Swiss franc) are only likely to reassert themselves once recent hot spots have cooled down somewhat and no new crises emerge. In this environment our forecast calls for a moderate weakening in the Swiss franc against the euro to around 1.14 until Q4 2018. However, a minimum exchange rate is no longer enforced. Should certain risks materialize (e.g. geopolitical conflicts, intensification of global trade conflicts or turmoil in the EU), the Swiss franc could once again appreciate rapidly and strongly.

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