EUR: Once again we revise our forecasts for EUR to the upside to account for the recent very disappointing US data, the persistent dovish shift in the Fed’s outlook and the change in the reaction function of the ECB.
While we expect the Fed to resume its tightening cycle later this year, we believe that the shift in the ECB's focus away from trying to cheapen EUR and towards boosting domestic demand through the Eurozone lending channel is here to stay. Our new projections still see EUR/USD on a gentle downtrend, mainly because we still expect the Fed to deliver a total of four rate hikes this and next year.
In addition, the Eurozone BoP data suggests that the portfolio outflows from the Eurozone are persisting, and we expect this to cap any sustained appreciation of EUR. The outflows could intensify further once the ECB start purchasing EUR-denominated corporate bonds in June. Last but not least, recent ECB comments as well as the March staff macro projections suggest that the Governing Council is unlikely to tolerate sustained EUR/USD appreciation above 1.16 for now.
AUD: The RBA surprised markets with a 25bp rate cut this month, putting an end to the AUD rally. From current levels, we see limited scope for further AUD/USD upside given AUD long positions are now at extended levels (as indicated by our G10 positioning index – Longs in commodity currencies starting to look stretched); moreover, sentiment towards the USD is already quite bearish.
Domestically, growth is expected to continue at a moderate pace, supported by domestic demand as the economy continues to rebalance away from the mining sector. However, inflation remains at low levels, and inflation expectations have been drifting lower and labour market data has been mixed of late. Looking ahead, lingering global growth concerns and uncertainty on China could weigh on risk sentiment, and question marks over the sustainability of the recent recovery in commodity prices pose downside risks for the AUD given the extent of AUD long positioning. This also supports market pricing of a further rate cut later this year.
We retain our bearish view on AUD/USD supported by diverging monetary policies and the arguments stated above. We forecast AUD/USD to maintain a downward trajectory over the next year, reaching 0.70 in Q217.
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