G10 FX Week Ahead: The Show Must Go On

We expect markets to resume their risk-on stance next week, with news about second Covid-19 waves only having a short-lived effect. The dollar may thus re-establish its downward trend, and not just to the benefit of pro-cyclical currencies. Central bank decisions in the UK, Japan, Norway and Switzerland appear set to have limited FX implications

DXY: Back to the downtrend, despite second waves

• The resurgence of Covid-19 cases offered a motive for some aggressive profit-taking in equity markets after a long rally. If this week was about a physical correction, next week will tell us how solid market appetite is. We suspect that while headlines about second waves in the US may temporarily upset sentiment, risk assets may once again prove resilient, still counting on the Federal Reserve's printing machine and taking heart from the restart of the global economy. Moreover, new Covid-19 waves will have an impact on markets only if there is a material indication that this implies fresh lockdown measures will follow. Data-wise, strong US retail sales may contribute to the V-shape recovery narrative, although industrial production numbers were likely curbed by the battered oil and gas sector.
• We expect the dollar’s bear trend to start consolidating again next week, warranted not only by some resilience in risk sentiment but also by the now cemented notion that the Fed remains highly committed to an extra dovish stance, and the feeling that it stands ready to pump up its quantitative easing if the stock market comes under severe pressure again. In line with some recent dynamics, we may be looking at more broad-based dollar weakness, not just to the benefit of pro-cyclical currencies.

EUR: The march to 1.15 continues

• The euro has proven resilient to the dollar rebound, and the EUR/USD drop has so far been contained within the 1.13 area. More signs of dollar weakness next week may offer a chance for the pair to re-establish a mildly bullish trend, eyeing the 1.15 mark.
• However, in order to break above 1.15, a clear EUR-positive catalyst may have to come into play. Next week’s EU summit on the Recovery Found may yield some encouraging headlines, but will likely be only the first step in the negotiations between those backing the original proposals and those opposing burden-sharing. While the meeting may help to reinforce the floor under the EUR, it may not be enough to break the 1.15 resistance.

JPY: BoJ still a non-event for the yen

• The yen jumped as much as the euro in the aftermath of the Fed meeting this week following a solid depreciation in the USD/JPY over the previous two weeks. This may be a sign that the weak dollar story is not only a function of market optimism (a JPY-negative), but a broader one. As risks of second waves start to emerge, equity markets may come under pressure over the short-term, which could offer some support to the yen and help USD/JPY edge back towards 105.
• The Bank of Japan meeting next week should once again be a non-event and hardly a hindrance to JPY resilience. The Bank has notably run out of tools to support the economy after committing to unlimited bond purchases and already having negative rates in place. The ultra-dovish stance is set to remain in place, and the market is already fully aware of it. 

GBP: The UK-EU meeting to offer little real progress on trade talks

• As the UK government formally confirmed it won’t seek an extension to the transition period, the main focus next week is on a meeting between UK Prime Minister Boris Johnson and EU Commission President Ursula Von der Leyen (Monday). Given that the key points of contention remain (such as state aid) we don’t expect any meaningful progress. The language may be non-negative (ie, hints at intensifying talks) but little real positive news should come from the meeting. Even if a trade agreement is struck later this year, the change in the UK-EU trading relationship will be a negative for the UK economy next year. Next week may be neutral for GBP, but the multi-month outlook for the pound remains negative.
• On the UK data front, the Bank of England meets on Thursday and we expect it to expand its QE programme by £150 billion. An extension of QE is expected by the markets and should therefore have a limited impact on GBP. Still, the uncertainty about a UK-EU trade deal should prevent markets from pricing out the possibility of negative rates in the UK.

AUD: Dealing with a tired rally

• The Australian dollar's extraordinary rally has come to an end this week. A resumption of such a run next week will not only depend on the performance of global equities (and news about second waves) but also on some key employment data in Australia. A Bloomberg survey suggests the consensus is centred around a 75k drop in employment in May, but after the extraordinary payrolls’ numbers in the US (and Canada), markets might be disappointed with a negative read.
• With the bar for positive surprises set quite high, the AUD still dealing with the sense that the recent rally was overdone and an unresolved (and very dangerous) diplomatic spat with China creeping in the background, we don’t expect AUD to be back on investors’ preference list next week, even if risk remains supported.

NZD: Helped by the successful virus policy

• If it’s true that the Aussie dollar rally looked overdone, the same can likely be said for the New Zealand dollar, with the two currencies moving hand in hand at the moment due to a lack of idiosyncratic catalysts. While AUD will have to deal with labour data next week, the key release in New Zealand will be 1Q growth figures, which are likely to show a contraction but should have limited explanatory power as most of the restrictions were applied in 2Q. Incidentally, the market is fully pricing in the recession in NZ and the reading should have no long-lasting impact on NZD.
• However, the ability of New Zealand to wipe out the virus arguably bodes well for the currency, as both consumption and tourism (NZ is likely going to be white-listed by most countries as a travel destination) may well get a boost. We expect NZD to outperform AUD next week.  

CAD: An attractive outlook

• The loonie appears to have a more attractive risk-reward profile than other commodity currencies in the G10, as the recent astonishing rebound in employment and more sustainable oil prices for Canadian producers suggests fundamentals for the currency have likely improved.
• Next week’s calendar includes the inflation report and retail sales for April, with the latter likely having a greater potential impact on CAD. All in all, if risk sentiment continues to prove robust next week, we expect CAD to be at the forefront of the G10 scorecard, barring major setbacks in crude prices.

CHF: SNB to remain cautious on the franc

• Along with global-risk sentiment, the Swiss franc will be driven by some internal factors next week. The Swiss National Bank meets on Thursday, and while there’s little doubt they will stick to a recipe of negative rates and FX intervention if needed, markets will closely watch the Bank’s economic projections. The KOF institute will also publish some forecasts, which are usually well regarded by investors.
• All comments on the FX intervention tool will be closely watched, as EUR/CHF has moved quite drastically away from the 1.05 mark that was widely seen as a line in the sand for the SNB. That said, it seems unlikely the Bank will have any interest in signalling a looser stance on the franc, which may spur unwanted speculative buying in the currency. All in all, the impact on CHF may be balanced and EUR/CHF may move back above 1.08 next week.  

NOK: No surprise from the Norges Bank

• The Norges Bank meeting on Thursday is the key data point in Norway. We expect the NB to stay on hold. With rates already at zero and no central bank appetite to push them into negative territory or embark on QE, the NB seems to be done with easing during this cycle. Rising oil prices also limit the need for further easing. The NB meeting should be a non-event for the krone.
• Instead, the currency should continue to be driven by general risk sentiment. We view the post-FOMC sell-off in risk assets as more a function of profit taking than a change in the trend. With risk sentiment likely to be more supportive next week, EUR/NOK should see a gentle downward bias.

SEK: Driven by general risk sentiment

• It is a very quiet week on the Swedish data front, with the main driver of the krona being the external environment. The modestly supportive backdrop for risk should keep EUR/SEK below the 10.50 level next week.
• The Swedish krona continues to benefit from one of the highest real rates in the G10 FX space and a Riksbank which is no longer overtly dovish (this contributed to the SEK's underperformance in prior years).