USD Strength to continue, GBP weakness and event risk, CZK

USD: Gentle USD strength throughout the week.  We expect USD to trade with a gentle upward bias this week. The main economic data event of the week is the December US CPI (Wed). We expect the reading to tick above 2% YoY (for the first time since mid-2014). This should benefit USD via the higher UST yield channel. President-elect Trump’s inauguration speech on Friday is likely to strike an optimistic tone, yet in terms of new news flow, it may not be enough to materially move USD.

EUR: The euro reaping the short-term benefits of the Brexit risk. It is a fairly quiet day/week on the EZ data front. Not only should EUR do well against the Brexit-battered GBP, but we also expect Brexit spill-over related EUR gains to manifest themselves against SEK. SEK has been one of the few currencies to negatively feel the Brexit spill-over last year, causing EUR/SEK to trade with persistent Brexit risk premia (as some market participants perceived Sweden as potentially the next-in-line non-EMU country vulnerable to EU exit swings). EUR/SEK to move above the 9.50 level this week.

GBP: More Brexit risk premium to be built into GBP.GBP is under heavy pressure ahead of tomorrow ‘s PM May speech on the UK government’s Brexit strategy. While the Brexit risk premium has yet again started being built into GBP, it is still nowhere near the extreme levels of October 2016 (worth c.10% in EUR/GBP at the time vs 3.3% at this point). We still see more upside to EUR/GBP and expect the cross to break above 0.90 in coming weeks/months, potentially testing the last year’s ex-sterling flash crash highs of 0.9140. This would coincide with the historically extreme EUR/GBP medium term overvaluation. While the potential Supreme Court ruling on Article 50 may provide short-term respite to GBP (if the government is forced to seek the approval of Parliament), this is unlikely to be long lasting as Parliament is likely to approve the June referendum outcome.

CZK: Will more than EUR20bn of speculative capital find a counter-party? We worry the market is getting/going to be excessively short EUR/CZK. Based on our estimates, there may be around EUR 20bn of “fresh” speculative capital currently waiting for the CNB exit from the EUR/CZK floor (and more may flow in coming weeks/moths). This may make the price action on the EUR/CZK floor exit day rather tricky – even if the EUR/CZK declines towards its far value of 25.50 over time. Hence, to err on the side of caution, we close 50% of our short EUR/CZK position as a correction in overstretched long CZK positions may be overdue.