EURJPY - Yen consolidates in new trading range

EURUSD - Support at 1.05 should be tested again

EURJPY - Yen consolidates in new trading range

EURCHF – Swiss franc remains strong

US dollar could strengthen in the short term, we are skeptical about its medium term prospects

In December EURUSD briefly declined to levels below 1.05, in the process breaking support that had held for more than two years. The move was sparked by Donald Trump winning the US presidential election and the associated rise in expectations for economic growth and hence interest rates. Since then a counter-trend move has set in, likely triggered by profit taking, but surely also driven by the fact that very little was heard from the incoming administration regarding the specifics of its economic plans (tax cuts). Overall, US economic data were good, but they were not strong enough to justify the high levels the dollar had previously reached.

We expect the US dollar to strengthen in the short term, with the market driving EURUSD down once again. However, we are skeptical regarding the sustainability of such a move. The dollar trades already at a very lofty valuation, based on valuation criteria such as the yield differentials between short term German and US government notes and their expected future trends. We also believe that the Federal Reserve would regard a strong rally in the dollar (toward parity with the euro) as having a dampening effect on economic growth and that it would signal this to the markets. Declining interest rate expectations would then deprive the dollar's appreciation of its foundation. The risk to our forecast consists of the new government passing economic stimulus measures of a magnitude that clearly boosts inflation risks and forces the Fed to act quickly. In that case a sustained and substantial rally in the dollar should be expected.

JPY – yen consolidates in new trading range

The Bank of Japan announced no noteworthy changes to monetary policy at its last meeting (20. Dec. 2016). In order to reach its inflation target of 2% as soon as possible, the BoJ continues to rely on negative interest rates, QE (approx. JPY 80 trn. per year), as well as control of the yield curve. Moreover, the BoJ has pledged to overshoot its inflation objective until the 2% target is exceeded in sustainable and stable fashion. Should yields in the US continue to rise in line with our expectations, control of the yield curve in order to hold the yield on 10- year Japanese government bonds (JGBs) at a level of approx. 0% could become an increasingly difficult challenge for the BoJ. 10-year JGBs are already trading in a range of 0.05% to 0.1% since mid November.

After a sizable decline until mid December of last year, the euro-yen cross rate has settled into a very tight trading range between 121 and 123. In view of the BoJ's intention to keep the yield on 10-year government bonds at 0%, we expect the yen to lose ground in the event of a global surge in bond yields. Conversely, should bond yields in the rest of the world decrease, the yen should strengthen.

Technically the EURJPY cross has established a foothold above the 120 level. The 50- and 100-day moving averages are rising, signaling a continuing uptrend. Thus, from a technical perspective a further depreciation of the yen against the euro over the medium term should be expected. In the short term the upside is likely to be capped by the next important resistance level around 123, while the 120 level should provide downside support. The analyst consensus is calling for a stabilization of the cross rate at a level of approx. EURJPY 121 by the end of 2017.

EURCHF – the Swiss franc remains strong

After strengthening noticeably in October and November (triggered by Donald Trump's victory in the US presidential election) and a period of heightened volatility in the first half of December, the Swiss franc has remained strong over the past month, trading at approx. 1.07 per euro.

In its monetary policy assessment of December 15, the Swiss National Bank has left three month Libor at an unchanged target range of -1.25% to -0.25%, and the interest rate on sight deposits with the National Bank at -0.75%. The SNB also revised its conditional inflation forecast slightly downward compared to September. The SNB expects an inflation rate of 0.1% in 2017 compared to 0.2% according to the September forecast. The projection for 2018 was lowered from 0.6% to 0.5%. The forecast is based in the assumption that three month Libor remains at -0.75% over the entire forecast horizon.

Fundamental factors currently indicate no significant easing of appreciation pressures on the Swiss franc. With the revision of the SNB's inflation forecast, the inflation differential between Switzerland and the euro zone is widening still further. Moreover, uncertainty in global financial markets remains pronounced. As a result, the Swiss franc continues to be a highly attractive safe haven currency, despite negative interest rates. The SNB emphasizes over and over again that the Swiss franc remains greatly overvalued and that it "...will be active in the foreign exchange markets as necessary". Taking into account the fundamental data as well as the situation in the financial markets, we have revised our forecast for EURCHF slightly downward. According to our new estimate, EURCHF should fluctuate between 1.07 and 1.08 in the coming months. Over the remainder of the year we are forecasting a moderate decline in the Swiss franc to around 1.11 francs per euro by Q4 2017. However, a minimum exchange rate is no longer enforced. Should certain risks materialize (e.g. geopolitical conflicts, turmoil in the EU), the Swiss franc could appreciate rapidly and strongly again.

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