FX Daily Strategy: Asia, March 21st

USD to continue to edge higher against the EUR

GBP to sustain gains but upside modest

JPY strength to continue, but more equity weakness required to extend gains

AUD down, but not out

Friday looks like a fairly quiet day for data, with nothing of note in any of the majors, and it’s hard to finds any obvious drivers for FX markets. The USD has managed a modest recovery against the EUR in the last couple of days, and this could extend a little judging by the correlation with yield spreads. The EUR has also benefited to some extent from the relative strength of the European equity market since the beginning of the year, but this is also showing signs of petering out. While it remains likely that Germany will be enacting a debt financed increase in defence and infrastructure spending in the next year, it is still unclear how large this stimulus will be and whether it will be enough to provide some much needed growth momentum to the economy. For now, there is some scope for EUR/USD to continue to edge lower to 1.08.

GBP was one of the better performers on Thursday, with UK yields rising after the BoE MPC decision, helped by comments from governor Bailey suggesting that rate cuts would be slow because the fall in inflation has been very gradual. Nevertheless, we feel the market is underpricing the likely extent of rate cuts, with just two priced in by the end of the year, so we don’t see a lot of downside risk for EUR/GBP. The pound remains expensive from a long term perspective, and more obviously so when looked at in real terms. The relatively slow decline in UK inflation also means that real UK yields are less attractive than nominal yields suggest. EUR/GBP may still have scope to drop back to near 0.83, but we would expect longer term buyers to emerge there.

The JPY was the best performer on Thursday, although it retraced the gains seen in Asia in the European session. 150 now looks very toppish for USD/JPY, with yield spreads pointing substantially lower, and we also see 164 as likely to be a medium term top for EUR/JPY. But it will still likely require clearer weakness in US equities if the JPY is to make more ground.

The AUD was the worst performer on Thursday, hit initially by much worse than expected employment data and subsequently suffering from the more negative risk tone, particularly in Asian markets. An immediate recovery will be difficult, as there will now be some uncertainty about the trajectory of the economy following the fall in employment in February. However, this is probably a flash in the pan, and unless there is more evidence of weakness, we would expect a reversal to be seen in the March data. Bigger picture, we still see the AUD as good value below 0.63 provided there is no serious downturn in the global economy.