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The week ahead: the USD as a carry currency and safe haven – Nordea

In a review of the upcoming week, Nordea Research is noting the USD’s strength despite Friday’s capitulation, and the Greenback’s safe haven status could see further gains in the week ahead.

Key quotes

“While the trade war rages, the USD has had another relatively strong week, especially against currencies like the AUD, the CAD and the NZD. The reason is pretty obvious; the USD is a carry currency and a safe haven at the same time currently. And recently periods of risk off have coincided with a relative re-steepening of the USD curve versus the EUR curve, which has tended to coincide with lower EUR/USD (when the USD curve has re-steepened) over the past 1-2 years.

Over the weekend Trump has added to the trade worries, by promising a 20% tariff on European car exports to US, if European trade barriers on autos are not lowered.  We still hold the view that a trade war is ultimately long-term USD positive.

Next week the EU summit could prove to be a market mover as a weak final message from the EU leaders would add fuel to the lately de-integrating sentiment in the Euro area after the Italian worries. Thus, the EU summit risks spell more trouble for the EUR and widen the intra-Euro-area bond spreads, if no further progress is made on the integration measures. And with the recent mudslinging between CDU and CSU, Merkel is not in an optimal position to agree on further EU integration measures just now. We are not betting on a particularly fruitful meeting.  We stick to short EUR/USD, if not for spot reasons, then at least for carry reasons.

The Fed is gradually letting its balance sheet shrink at a quicker and quicker pace, with a maximum shrinkage of USD50bn/month reached in Q4, 2018 (of which 30bn can be bonds and notes). On some days, liquidity shrinks a lot, most other days not at all. Interestingly, on days when the daily impact on US liquidity is large, the dollar has tended to gain, and risk sentiment has been weak.

As the company report season approaches, we would.like remind our readers about one interesting consequence from the recent rise of the dollar. As roughly half of S&P500 revenues stem from abroad, the recent dollar move will cut analysts’ 2019 and 2020 EPS forecasts, possibly by 2-2.5%. As an example from the recent past, when the dollar had picked up speed during the third quarter report season of 2014, it prompted lower EPS forecasts for 2015 and 2016.  

As we mentioned in the beginning of this edition of the weekly, we consider the reason for the USD strength versus CAD, NZD and AUD very obvious. As the USD yields better than the CAD, the NZD and the AUD, why on earth should investors decide to “park” the money in either of the three in the current global environment marked by increasing trade risks? The USD is simply the best carry currency in the world at the moment and hence we also stick to our AUD/USD short for the time being.

The commodity currency with the net longest positioning is currently NZD and it should be the one that is most obviously vulnerable to further setbacks in the risk sentiment as a consequence. We therefore decide to add a short NZD leg to our long JPY case ahead of the election in the Liberal Democratic Party in September, due to the risk that Shinzo Abe will be ousted from his post (a JPY positive risk scenario). We think that the market will have to price in a positive risk premium in JPY due to this election rather sooner than later.”

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