No Rush for Carry

The long USD trade requires a pickup in US data. Until this happens, USD is vulnerable to further downward correction

USD Requires a Stronger US. It’s a simple point, but an important one. With deflationary risks subsiding outside the US and less aggressive easing globally, a USD revival needs a pickup in US economic activity. Yes, labor markets are looking healthy overall, but we’d like to see more evidence of consumers putting income to work before we add fresh USD longs against the majors. That said, we are not in a rush to add USD shorts against any currencies, given that a durable global recovery is unlikely without a strong US consumer.

Not Adding Carry. Global market volatility makes highcarry currencies unattractive on a vol-adjusted basis.
While EM has traded reasonably well amid the rise in core market back-end yields, we think this reflects temporary factors, such as the swift rebound in commodity prices and stable-to-lower front-end rates. This dovish Fed re-pricing won’t last forever, and all it could take are a couple of data points to renew faith in Fed tightening this year to change the story. Rallies in structurally vulnerable, high-carry EMFX are unlikely to last beyond a few weeks, we think.

Watch Asia… While deflationary risks have subsided in much of the world, there is still one region where disinflation is a major concern and central banks could surprise markets with more easing. AXJ countries face a challenging combination of overcapacity, upward pressure on real interest rates and high real effective exchange rates. We expect more pushback from central banks here, and continue to express this view with THB shorts. We also maintain short positions in AUD and NZD, where central banks are uncomfortable with elevated exchange rates and are likely to push back aggressively, especially if expectations for Fed hikes are further delayed.

…and Focus on Relative Value. This week, we examine a post-election UK economy, which is in pretty good shape. We add a short EUR/GBP position as the ECB is highly unlikely to raise rates any time soon, while UK frontend rates are likely to rise as we approach the first hike.
Over the long term, GBP risks remain, including a large current account deficit, more aggressive-than-expected fiscal consolidation and a ‘Brexit’ referendum. But in the near term, we like positioning for the cyclical UK recovery.

Global Currency Research Team – Morgan Stanley