FX

I believe the next catalyst for the USD appreciation will be an increase in real yields, which in my view have become the dominant driver of the currency, rather than nominal yields.Evidence that the US output gap is narrowing should prompt higher US real yields and a stronger USD. Given weak growth and low inflation expectations, real yields in Europe and Japan could do with staying low; however, with nominal yields already in negative territory there will in fact be a tendency for real yields to rise in Europe and Japan as inflation expectations fall. This should keep EUR and JPY strong. For many EMs, especially those with weak fundamentals and external vulnerabilities, the relationship is inverse. As real yields increase in the US, we’d expectEM currency weakness and an increase in EM real yields. The exceptions are the DM-like EMs, such as Korea, where we’d expect an eventual drop in real yields to drive KRW weakness. Short term price action has been sideways in most currencies. USD stil remains in range after recovering from lows in the last two weeks. Yellen remains key in finding direction, the oil rally has helped some commodity currencies recover some ground but has not really sparked a rally. Emerging markets have recovered somewhat but it seems to be a fragile rally so far, it has not gone deep enough to undermine the recent USD rally and fundamentally weakness persists. Trend wise uneventful day ahead.

GFX