USD and China, EM currencies, UK Data

China preemptively dealing with capital outflow risks and Mexico interveninghave allowed the USD to correct gains witnessed since November. However, USD corrective activity should be limited. Notably, we believe the current situation has too few similarities to January 2016 when a USD rally was followed by a 6.5% downward correction. Importantly, China preventing capital outflows will help to keep the current global reflationary theme alive for longer and seeing the USD rallying against low-yielding currencies is part of the global reflation trade.

EM currencies offering a solid domestic story have fared well, keeping their access to the global funding pool intact, thereby showing a substantial difference to last year when EM funding conditions tightened by the day driven by weaker currencies. The current USD rally has predominately materialized against low-yielding currencies. There is a reason risky assets tend to rise when there is EUR and JPY weakness, as weakness in these currencies improves global liquidity conditions – as opposed to EM currency weakness, which tends to weaken global liquidity conditions. We add long USD trades vs the EUR and NOK to our already short KRW position.

Continued strong UK data releases have not been sufficient to keep GBP supported. Worries about the British government finally triggering Article 50 and investment spending reacting to increasing planning insecurity should put GBP under renewed selling pressure. We expect GBPUSD easing moderately to 1.17 with the global reflation theme preventing a bigger setback. However, it would still make sense to trade GBP short against a global reflation winning currency. The SEK falls into this category, suggesting GBPSEK shorts offer value.

Additionally, we sell into the current EURUSD rally. Continued ECB dovishness suggests rising inflation rates pushing EUR real rates and yields lower. Over the next few weeks, we see better EUR downside potential compared to the JPY, which took most of the weakening effort from November into this year. EURJPY may correct moderately lower.