As we head into 2015, a few themes dominate the FX market and they will have substantial impacts on to currencies

  • Firstly, Oil prices will play a hefty role in determining monetary policy, as well as inflation expectations. So far this year, Oil is down some 36%

  • Secondly, the market is still underpricing US hikes... now we may see a change to the fundamentals, but as it stands the US rate market is still way of the pace of the Fed and Taylor rule estimates Looking at each currency bloc in turn we can see the potential moves.

GBP outlook

Near term risks for GBP are on the downside as remaining bulls capitulate with the weakening inflation picture. The basing of inflation would mark the low in market rate expectations and set the GBP base as well.

A potentially doubly hung parliament adds to well flagged uncertainty around May’s General Election. Investors don’t see any positive outcomes for GBP, with a Labour majority/coalition bad for business and Conservative majority/coalition raising prospects of Brexit.

When we look at risks going forward, the options space is pricing in some interesting moves for next may... if we look back to the scottish referendum it is far less significant in comparison and we saw plenty of volatility around that time.

On the Macro side, it appears there is little slack in the market, and with falling unemployment rates, it is likely we see upward pressures to rates - as such we could see an out performance of the GBP against most G10, just maybe not the USD.

Price target - I expect the Cable to be range-bound between 1.55 and 1.60

EUR outlook

5 reasons for EUR weakness, very few for strength...

1. Policy gap: Citi’s house forecast is for an expansion into sovereign purchases starting January 22. We forecast to reach the desired €1tn balance sheet expansion; the GC will need to purchase an additional €75bn of assets per quarter (€25bn per month).

2. FX Cycle: A typical EUR cycle has 5-10 years of weakness, 10 years of rally and a bit of consolidation in between. By this metric EUR has 5 more years of weakness. However looking at technical analogues like this rarely become fruitful.

3. Deflation and energy: Market expectations continue to fall as per the 5y5y forward. Oil and energy weakness places headline CPI at or below 0% in Q1 2015 which is likely to cause further action from the ECB

4. Real Rates: Any European solution needs lower real yields. This is far from easy. Rates are already essentially at their lower bound. A weaker EUR is the quickest and simplest fix to deflation and act for lower nominal rates.

5. Investor rotation: It no longer “pays” to receive EZ rates. 10y Bunds have fallen to 0.7%, French debt is below 1%, Spain below 1.9%. 10y Treasury yields are 2.2%. This rotation from Japanese investors toward US instead of EZ debt could lead to further EURUSD weakness.

These charts demonstrate some potential for a slower decline than the market expectation. The EUR has overshot rate spreads, the market is heavily short, and at the same time - a strong and growing current account surplus. However, while these are technically bullish points when considering the relative magnitude they are less important and may only cause a small rally which should be sold.

Price target - look for the EUR to trade lower to 1.20... but the decline will slow

CHF outlook

I expect CHF to retain its strength against the EUR (EURCHF 1.20), until the SNB can sufficiently offset European deflation or the Eurozone outlook improves. SNB policy may be expanded over 2015, but the timing will depend on exhausting current capabilities and greater balance sheet expansion.

However if one believes in the 2015 growth story, then EURCHF is a good bet to play. Personally speaking an option risk-reversal trade is the best, especially as we trade towards the lower bound and there is little chance of a sub 1.20 EURCHF in the next year.

As such, selling 1.2005 puts to buy 1.21 calls, as my price target is 1.22

I look to cover the last currencies in another post before 2015, Thanks for reading

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