09/12 Key highlights - Lombard Odier...of the year (at 1.15) are somewhat to the downside. However, we believe that we have seen the bottom. With EURUSD implied volatility having risen

FX MonthlyNavigating FX as major central banks

ease further

Monthly publication of Lombard Odier Investment Solutions – Investment Strategy department

Contributors: Vasileios Gkionakis, Head of FX Strategy [email protected] Lee, Macro Strategist Asia: [email protected]: [email protected]

Important information: Please read important information at the end of the document.

Data as of 19 September 2019

FX Committee targetsQ4 19 Q2 20

EURUSD 1.15 1.17GBPUSD 1.27 1.32EURGBP 0.91 0.89EURCHF 1.10 1.10EURSEK 10.77 10.70EURNOK 9.85 9.75USDCHF 0.96 0.94USDJPY 104 105USDCAD 1.32 1.29AUDUSD 0.68 0.70NZDUSD 0.63 0.63USDCNY 7.10 7.00

At a glance

· FX forecast table 04

· EUR 05

· CHF 07

· GBP 08

· JPY 10

· CNY 11

· Nordic currencies 13

· Commodity FX 14

09/12September 2019

Key highlights· USD still benefiting from safe haven flows but degree of overvaluation is now

considerable and is likely to weigh going forward

· We maintain our upside bias for EURUSD, given rate differentials and plenty of negativity already in the price

· At the same time, we stay neutral on the Swiss franc

· USDJPY may consolidate somewhat in the near term due to seasonality, but medium term there is still scope for further downside

· A no-deal Brexit on 31 October is now unlikely but the tail risk has not been removed completely. GBP still incorporates a sizeable risk premium

Please read important information at the end of the document.Lombard Odier · FX Monthly · September 2019 Page 3/21

Major central banks have eased monetary policy further. The Federal Reserve Bank (Fed) cut its target rate by 25 bps while the European Central Bank (ECB) announced a bold and comprehensive package that resulted in more negative rates and the restart of asset purchases.Effectively, currency markets are likely to grapple with opposing forces: more accommodative monetary policy, which pushes investors towards carry trades (risk-positive), but also ongoing uncertainty revolving around the US-China trade dispute and the recent escalation of tensions in Saudi Arabia (risk-negative).The dollar will continue to be seen as a safe haven by investors, mostly against cyclical and externally exposed currencies. However, its degree of overvaluation (divergence from rate differentials) has widened considerably and should start to weigh going forward. More specifically, we maintain a small upside bias for EURUSD over the next few months. Despite the ECB’s bold package, the measures were not enough to supress the common currency. Moreover, rate differentials with the US suggest that EURUSD should be trading somewhat higher while plenty of negative news is already in the price.We retain our neutral stance on the Swiss franc: risk appetite remains fragile, which will be a positive for the currency; however, the SNB demonstrated that intervening in the FX market remains a live option, at least to arrest any CHF appreciation. As far as sterling is concerned, the recent developments suggest that a no-deal Brexit on 31 October is a very unlikely event. That said, the tail risk has not been removed

Navigating FX as major central banks ease further

entirely, which means that GBP still incorporates a sizeable risk premium.Turning to JPY, there are odds of some consolidation in the near term following its rally earlier in the year and negative JPY seasonality during October and November. However, the cycle is very mature, risk is likely to remain on the defensive, and JPY is still quite undervalued. In that sense, there is scope for further downside in USDJPY from a medium-term perspective. At the same time, we remain of the view that China has managed the trade disputes with the US in a cautious and controlled manner. This is why USDCNY, after rising close to 7.20, has declined since to below 7.10. Unless frictions intensify, we see little reason for CNY to trade materially weaker. In the Nordics, we still prefer the NOK over the SEK, while in the core commodity bloc we think AUD has some room to rebound after its multi-month depreciation. CAD is supported by fundamentals and recent developments in oil prices.

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Note: Past performance is not a reliable indicator of future performance.

Page 4/21Please read important information at the end of the document.

Lombard Odier · FX Monthly · September 2019

FX Monthly – Navigating FX as major central banks ease further

Current spot Q4 19 Q1 20 Q2 20 Q3 20 Estimates of long term fair value1

EURUSD 1.11 1.15 1.16 1.17 1.17 1.15

GBPUSD 1.25 1.27 1.30 1.32 1.33 1.40

EURGBP 0.89 0.91 0.89 0.89 0.88 0.82

EURCHF 1.10 1.10 1.10 1.10 1.10 1.13

USDCHF 0.99 0.96 0.95 0.94 0.94 0.99

USDJPY 108.00 104 104 105 105 99

EURJPY 119.52 120 121 123 123 114

EURSEK 10.74 10.77 10.75 10.70 10.70 9.44

USDSEK 9.71 9.37 9.27 9.15 9.15 8.21

EURNOK 9.90 9.85 9.80 9.75 9.70 8.99

USDNOK 8.95 8.57 8.45 8.33 8.29 7.82

USDCAD 1.33 1.32 1.30 1.29 1.28 1.28

AUDUSD 0.68 0.68 0.69 0.70 0.70 0.76

NZDUSD 0.63 0.63 0.63 0.63 0.63 0.66

USDCNY 7.09 7.10 7.05 7.00 6.95

1 The estimates of long-term (LT) fair values are calculated as the average value estimated using FEER and BEER models. The FEER (fundamental equilibrium exchange rate) model calculates the exchange rate required to bring macroeconomic balance, i.e. full-employment, low inflation and a sustainable current account balance. The BEER (behavioral equilibrium exchange rate) model uses econometric methods to estimate equilibrium FX rates based on a set of macroeconomic variables (our model uses terms of trade, investment as a share of GDP, and real rates within a panel data set across G10 FX). Please refer to page 16 for a more detailed explanation.

FX forecasts

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EURHave we seen the bottom?

· ECB’s easing package was bold, but not enough so to supress the EUR

· The currency has already priced too much negativity

· We see the odds in favour of some modest EURUSD appreciation in the next few months

The highlight of the past few weeks in Europe was the European Central Bank (ECB) meeting. The central bank’s easing package announced on 12 September was comprehensive and broad. Specifically:1. The ECB cut the deposit rate by 10 bps (to -0.5%)2. The central bank strengthened its forward guidance. The

ECB removed its calendar-based language (low or lower rates until at least the first half of 2020) with a stronger, more open-ended version, i.e. that rates will remain low or lower “…until [the bank] has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2%...”

3. Asset purchases were restarted at a pace of EUR 20 bn per month (beginning in November); importantly, there was no end date announced, so the programme is open-ended

4. The modalities of targeted long term refinancing operations 3 (TLTRO3) were improved

5. A two-tier rate system was introduced to mitigate the negative impact of negative rates on banks’ profitability

These measures included plenty for everyone. On the “hawkish” side, the depo rate cut was the absolute minimum (some market participants were expecting a reduction of 20 bps), the pace of asset purchases was on the lower side of consensus expectations, while the details of the tiering system triggered a rather abrupt upside in front-end rates (see chart 1). On the “dovish” side, there were two highlights. First, the stimulus package was very broad in terms of instruments utilized, i.e. signalling was strong.

Second, the time horizon of the asset purchase programme was left open-ended. Since late June (shortly after Mr Draghi’s speech in Sintra), EURUSD has come under depreciating pressure, falling from 1.14 to below 1.10. On the day of the ECB announcement, the pair touched an intra-day low of 1.0927, but eventually rebounded strongly to 1.11 and now trades around 1.1070.In our view, the reasons for the rebound can be summarised as follows. First, and despite Mr Draghi’s emphasis during the press conference that a significant majority supported the measures, it emerged afterwards that the governing council members were divided, and some doubted the efficacy of the policy changes. Second, and despite the open-ended nature of the QE, the general impression from the press conference is that ECB policy has reached it limitations (Draghi called the package “adequate”), and that potential fiscal policy response was needed to stimulate growth. Third, the details of the rate-tiering system have triggered an abrupt rise in short-term rates, further underpinning the EUR.

Sources: Bloomberg, Lombard Odier.

1. Short-dated German yields jumped on ECB easing package Yield in %, EURUSD in spot

1.08

1.10

1.12

1.14

1.16

-1.00

-0.90

-0.80

-0.70

-0.60

-0.50

-0.40

Jan-19 Feb-19 Apr-19 Jun-19 Jul-19 Sep-19

German 2Y yield EURUSD, RHS

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2. EURUSD trading below levels implied by rates and oil price All in spot terms


3. EURUSD implied volatility In percent

EURHave we seen the bottom?

We see no reason to change our medium term view, which remains cautiously constructive on EURUSD. The global macro backdrop developments remain very fluid (and subject to plenty of headline noise) while the euro area economic outlook is still subject to downside risks. However, negative news and ECB easing are largely in the price (rate spreads – following the Fed’s decision to cut by another 25 bps - suggest EURUSD should be trading around 1.16 – see chart 2) and the ECB action in September was by no means the “big bazooka” to deliver a sustained blow to the exchange rate.To be sure, risks to our current EURUSD forecast for the end of the year (at 1.15) are somewhat to the downside. However, we believe that we have seen the bottom. With EURUSD implied volatility having risen but still close to multi-year lows (see chart 3), it makes sense for investors to consider positioning for upside through call optionality.

4

6

8

10

12

14

Jan-15 Dec-15 Nov-16 Oct-17 Oct-18 Sep-19

EURUSD, 3M implied volatility, %

EURUSD, 6M implied volatility, %

1.0

1.1

1.2

1.3

1.4

1.5

Jan-10 Jan-12 Dec-13 Nov-15 Oct-17 Sep-19

EURUSD, actualEURUSD, implied by real rates and oil price

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CHFUpside momentum stalling

· CHF is subject to opposing forces

· A still uncertain global outlook should be a tailwind, but modest SNB intervention should counter any renewed appreciating pressures

· CHF to hover around 1.10 for the foreseeable future

The Swiss franc has appreciated by 1.5% (in trade-weighted terms) in 2019 and by just over 4% since the lows in late April. However, upside momentum has stalled since early August, with EURCHF trading around 1.09/1.10 since then and USDCHF fluctuating close to the 0.98/99 level (see chart 4).CHF gains were fuelled by the flaring up in risk aversion, driven by the deterioration in global outlook, itself due mainly to the intensification of the US-China trade dispute. In turn, this has resulted in a sizeable rally in core bonds, as markets positioned for central bank easing, and safe haven assets came under upside pressure. It is worth noting, however, that the CHF has lagged the JPY in this safe haven rally, most likely due to deeply negative Swiss rates. At the same time, it appears that the recent (modest) intervention by the Swiss National Bank (SNB) has managed to arrest the CHF appreciation, although it has been clearly insufficient to reverse it.Where do we go from here? Our view is that the Swiss franc will remain exposed to opposing forces resulting in relative stability, with EURCHF trading close to the 1.10 level.On one hand, the global outlook remains uncertain. The manufacturing slump seems ongoing, the bar for a material improvement in US-China trade relations is high, and core yields are low (although they have risen recently). Despite low correlations between the CHF and risk assets (by historical standards), it appears that risk appetite will be unable to recover in a sustainable way, and this is bound to have some positive impact on the Swiss franc. Looking at Swiss portfolio balance data and Swiss banks’ foreign liabilities, inflows to Switzerland have picked up, although nowhere near levels seen in previous risk-off episodes.On the other hand, the SNB has intervened in the forex market, but the magnitude of intervention is nowhere near the level of its exploit at the beginning of 2015, shortly after the EURCHF floor was abandoned (see chart 5). This response has been modest, likely reflecting the risks that the central bank sees associated with its extremely large balance sheet. In that sense, the SNB’s “presence” in the foreign exchange market can be seen as putting a floor under EURCHF rather than being sufficient to reverse the trend in the currency. The possibility of cutting rates further remains a possibility.On balance, we see these opposing forces roughly offsetting each other and keeping EURCHF relatively stable close to 1.10. Additionally, we see USDCHF on a very mild depreciating path, largely due to our medium-term bearish bias for the USD.


4. CHF upside momentum has stalled In spot terms


5. Swiss total sight deposits Weekly change, CHF mn.

0.91

0.93

0.95

0.97

0.99

1.01

1.03

1.05

1.09

1.13

1.17

1.21

Jan-18 May-18 Sep- 18 Jan-19 May-19 Sep- 19

EURCHF USDCHF, RHS

-5 000

0

5 000

10 000

15 000

20 000

25 000

30 000

Jan-14 Feb-15 Apr-16 Jun-17 Jul-18 Sep- 19

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GBPSterling reprieve but tail risk not removed

· A no-deal Brexit at the end of October now seems unlikely

· However, a hard disorderly Brexit could occur at a later date

· We maintain the view that a no-deal will be averted and that GBP will rally strongly on the back of it – though it is nearly impossible to predict when

The UK’s handling of Brexit developments has been in complete disarray these past few months. So far, the government has made little – if any – progress in stepping up its negotiating platform with substantial and realistic proposals. The UK parliament has been prorogued until mid-October, while the Remain camp has managed to pass a bill that requests the government to seek an extension to the article 50 deadline on 31 October if no agreement has been implemented by then. PM Johnson has faced humiliation by multiple rounds of defeat in parliamentary voting, most notably failing to secure a general election before the end of October.Most of these developments combined – while deeply concerning within the context of modern UK democracy – have pretty much ensured that a disorderly no-deal Brexit will not happen on 31 October. The latter has been sufficient a development to push sterling crosses higher. TW GBP has gained more than 4% since mid-August, GBPUSD is now trading above 1.24 and EURGBP below 0.89 (see chart 6). Going forward, there are two main scenarios that could have significantly different implications for sterling.Scenario 1 (less likely): The UK and the EU reach an agreement, which is ratified by the UK House of Commons. Hence, the UK leaves the EU on 31 October in an orderly fashion with an agreement in place. This scenario would be unequivocally sterling-positive and our current GBPUSD forecast of 1.27 for the end of this year would come under upside risk.Scenario 2 (more likely): No agreement is reached, the government requests an extension of the current deadline and general elections are announced as taking place potentially sometime in November. Although the avoidance of a no-deal Brexit by the end of October would offer a short-term support to sterling, it is worth emphasising two things. First, the currency would then start to fluctuate based on headlines/news on election opinion polls. Second, it does not entirely remove the risk of a no-deal Brexit at a later date.If the Tory and Brexit parties join forces through a common platform, they would stand a reasonable chance of obtaining parliamentary majority (see chart 7). Although there is a scenario in which a large majority would enable Boris Johnson to sidestep the hardliners and adopt a softer stance in EU negotiations (sterling-positive), there is also a scenario in which he simply carries on with harsh Brexit rhetoric with significantly higher odds of achieving a no-deal Brexit given his potential new parliament arithmetic (sterling-negative).


6. A big rebound in sterling All in spot terms

Sources: Wikipedia, Lombard Odier.

7. Opinion polls for the next UK general election Average of available opinion polls conducted so far in September

2019

64

66

68

70

72

74

76

1.0

1.1

1.2

1.3

1.4


GBPUSD

GBPEUR

TW GBP, RHS

33%

26%

18%

13%11%

0%

10%

20%

30%

40%

Conservatives Labour LibDem Brexit party Others

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The worst scenario would be a Tory/Brexit party thin majority, in which case Boris Johnson will still be held “hostage” by the hard Brexiters (sterling-negative). The positive scenario would be one which would see a Labour and LibDem coalition government. In such a case, a soft Brexit becomes a near certainty, while the presence of LibDems in the government ensures that potential business-unfriendly policies by Corbyn are kept in check (sterling-positive).It is difficult to predict the path and the endgame in this ongoing Brexit saga, especially since there have been myriads of turns and twists so far. That said, we continue to think it is more probable than not that a no-deal Brexit will be averted. This implies that we expect significant appreciation in sterling, which based on our estimates is undervalued to the tune of 12% (see chart 8). However, we do not think the time is ripe to recommend long GBP exposure to our portfolios because the tail risk of a disorderly Brexit has not been removed. In our view, it is better to wait for more clarity on relevant issues such the date of the likely general election, opinion polls, and potential coalitions among parties.

GBPSterling reprieve but tail risk not removed

Sources: Bloomberg, Datastream, Lombard Odier

8. GBP remains undervalued All in spot terms

1.0

1.2

1.4

1.6

1.8

2.0

2.2

Mar-08 Jul-10 Nov-12 Feb-15 Jun-17 Sep- 19

GBPUSD , actual

GBPUSD , LO long- term fair value estimate

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JPYUSDJPY upside appears limited

· Near term USDJPY is likely to consolidate, while upside is seen as limited

· Fundamentally, there is still scope for further USDJPY depreciation in the medium term

On a YTD basis, JPY is the best-performing G10 currency in trade-weighted terms (+3.2% – see chart 9), registering spot gains of around 2% against the US dollar. However, in mid-August USDJPY ran out of steam, while in September the pair has come under some appreciating pressure.While we think the bulk of yen appreciation has already taken place, we still hold on to the view that the yen has some further room to move up. That said, near term there is an increasing likelihood of USDJPY stabilisation around current levels – notwithstanding the recent escalation of tensions in Saudi Arabia. At the same time, we believe that the risk of a material and sustained JPY decline is limited. Below we elaborate on this view.The case for some near-term stabilisation can be made on a number of grounds. First, the market is no longer short JPY (the speculative community has turned marginally long), which implies that JPY is no longer subject to “short squeezes”. Second, there has been some optimism regarding developments on the US-China trade discussions. While there is little evidence to suggest a meaningful improvement, the market could use this as an excuse to take a breather from the August sell-off. In turn, this is pushing US yields a bit higher, supporting USDJPY. Finally, there appears to be an element of seasonal strength in USDJPY between September and November (see chart 10).All that being said, one should not lose sight of the big picture. The cycle is very mature and the global manufacturing slowdown is likely to keep pressure on US yields and risk appetite. The Fed has cut rates twice and, in our view, it is likely to cut again (despite a divided FOMC), which however is yet to reflect in the value of the dollar: USDJPY remains overvalued, while gold prices suggest the pair should be trading lower (see chart 11). On balance, we maintain our forecast trajectory unchanged. From a portfolio-construction perspective, we think that the case to initiate fresh USDJPY shorts at current levels is less compelling than six months ago. However, there is still some value in holding onto JPY long exposure as a hedge in global portfolios against the risk of a further growth slowdown/rising geopolitical tensions and a re-intensification in trade disputes. Finally, even if the Fed does not ease further the pressure on JPY from higher US yields will likely be offset by a sell-off in risk assets.

9. YTD performance of G10 FX All in spot terms


10. Some seasonal strength in USDJPY In spot terms


11. Mind the gap USDJPY in spot terms


-5%

0%

5%

10%

15%

2018 2017 2016 2015 2014 2013 2012 2011 2010 2009

OctNovOct - Nov

-8%

-6%

-4%

-2%

0%

2%

4%

TWJPY

TWCAD

TWCHF

TWNO K

TWUSD

TWGBP

TWEUR

TWAUD

TWNZD

TWSEK

1 000

1 200

1 400

1 60080

90

100

110

120

130

Jun-14 Jul-15 Jul-16 Aug-17 Aug-18 Sep- 19

USDJPY Gold, R HS, inverted

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CNYStill holding its ground

· China continues to exhibit strong bias to control the Trump-driven currency depreciation

· Our baseline scenario remains China’s maintenance of the yuan stability guidance and the US dollar’s eventual softening

When we revised our USDCNY forecasts after the re-escalation of the US-China tensions in early August, we assumed that Beijing would deem a 4-5% depreciation of the yuan (versus the US dollar) appropriate to offset Mr Trump’s new tariffs. Such a move would roughly correspond to a 2-3% decline in the CFETS renminbi index to 90. We assumed that, in line with our view on Beijing’s medium-term policy preferences, a shocking devaluation in excess of these new projections was not likely. A long-held floor for the yuan’s value was being breached, but a simple “glinting of the pistol” by China would suffice as the Trump administration and the US Fed were already hyper-sensitive to the financial market turmoil.Predicting how the dispute between the US and China will end is still a tricky business, but we believe that developments in the past few weeks confirm our assessments of disincentives for more aggressive escalation. On the US side, Trump’s wild back-and-forth on a “deal” with China, as well as his constant pressures on the US Fed to cut rates, clearly demonstrate his sensitivity to stock market prices ahead of the 2020 election. In retrospect, China’s currency move was rather effective in triggering the type of negative market response that motivates Trump’s caution. On the Chinese side, China has maintained substantial restraint despite letting the yuan breach important levels in early August in the immediate aftermath of Trump’s new threats. The CFETS renminbi index has been kept above 90 (see chart 12). The People’s Bank of China has been leaning against overnight spot moves by (1) fixing USDCNY on the stronger side vs the levels implied by overnight markets (see chart 13), and (2) using the offshore yuan as a stabilising anchor via lower CNH liquidity and higher rates (see chart 14).Outside the bilateral trade negotiation, an argument can be made that the impact of macro and policy should be neutral for the yuan. China’s headline activity indicators in August were disappointing, with industrial output, fixed asset investment, and retail sales all posting much weaker growth rates than the consensus expectations. The new data releases support the PBOC’s recent cut in reserve requirement ratios and signal towards outright benchmark rate cuts in the remainder of the year.

12. Implicit floor breached in August CFETS RMB Index (31 Dec 2014 = 100), USDCNY spot (inverted,

right)


13. PBoC has leaned against excessive CNY weakness The estimated or implied USDCNY fixing is based on previous day’s

closes of USDCNY, EURUSD and USDJPY. This approximates the framework used by the PBoC since 2015

Sources: CEIC, Bloomberg, Lombard Odier.

5.8

6.0

6.2

6.4

6.6

6.8

7.0

7.2

7.490

92

94

96

98

100

102

Jan-16 Sep- 16 Jun-17 Mar-18 Dec-18 Sep- 19

CFETS RMB Index ( left)CFETS index lower bound before AugustUSDCNY spot ( right)

"Counter-cyclicalfactor" in CNY

fixing (May 2017)

"Counter-cyclicalmeasures" (July 2018)

Trump-Xi summits

(Dec 2018, June 2019)

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

0.2%

0.4%

0.6%

0.8%


Percent difference between actual fix and estimated10D MA

PBoC fixes USDCNY higher than the level implied by market rates. PBoC has a bias for a "weaker" CNY

PBoC fixes USDCNY lower than the level implied by market rates. PBoC has a bias for a "stronger" CNY

Re-escalation in US-China

trade disputes

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CNYStatus quo ante

These moves are slightly currency-negative. On the other hand, Beijing’s apparent eagerness to invite more foreign capital through the removal of caps in Qualified Foreign Institutional Investor (QFII) and RMB Qualified Foreign Institutional Investor (RQFII) programmes goes against the thesis of renewed and further RMB depreciation. Furthermore, the US side of the equation is still in flux, with the Fed likely to cut interest rates again amidst weakening growth dynamics and the Trump administration ratcheting up its rhetoric on excessive strength of the US dollar. In our view, the baseline scenario for the yuan should be modest appreciation as long as China is comfortable maintaining the current range for the yuan. If China can accomplish that, the eventual softness of the US dollar should allow it to recover modestly in the medium term. It is also a positive sum game for the US and China, as the latter is courting portfolio flows more openly.

14. CNH markets continue to play a stabilising role %, key rates in both onshore and offshore markets

Sources: CEIC, Bloomberg, Lombard Odier.

2

3

3

4

4

5


CNY - SHIBO R (1M)CNY - Pledge repo rat e for depository institutions (7D)CNH HIBOR (1M)

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Nordic currenciesNOK subject to upside risks

· A mixture of tailwinds and headwinds is likely to result in some gradual NOK appreciation

· SEK risks a (likely) U-turn by the Riksbank, which would halt its recent appreciation

Contrary to our expectations earlier in the year, the NOK has come under immense pressure since mid-July, losing around 3.0% against the EUR and 5% against the USD (see chart 15). The reasons can be traced to the deterioration of global growth outlook, which has resulted in (1) subdued oil prices – until the recent flaring up of tensions in Saudi Arabia and (2) the market repricing interest rates a bit lower – despite the Norges Bank hiking the policy rate to 1.5% in September.Given the size of NOK depreciation in the past couple of months, we think the odds are in favour of some NOK appreciation over the next few quarters. The currency still screens as very cheap, domestic economic fundamentals remain healthy, inflation has moved lower, but the underlying measure is still above the Norges Bank target of 2% (currently at 2.1%). Moreover, the latest regional network survey continued to show solid growth in the business sector, while capacity utilisation is running high. Furthermore, current euro area/Norway rate spreads together with oil prices suggest that EURNOK is trading about 5% higher than it should be (see chart 16). Finally, the attack on Saudi Arabia’s oil infrastructure implies lower energy output as well as concerns about the Kingdom’s ability to safeguard its oil production. As a headwind, we see negative NOK seasonality in Q4 with EURNOK having appreciated in all of the past six years during the fourth quarter. On balance, we keep our forecast for 9.85 for the end of this year and 9.70 for Q3 20.Turning to Sweden, SEK experienced a more contained depreciation against the EUR since mid-July and August, and has managed by now to pare back some part of its previous losses, with EURSEK trading above 10.70 from 10.80 at the end of last month. The reason for the reversal is rooted in improved risk appetite in early September on one hand, and on the other, in the ongoing hiking bias by the Riksbank. Although economic dynamics at home, including lower inflation, solid but slowing growth, and materially weaker economic sentiment (see chart 17) would all argue for the central bank to adopt a more cautious stance, the Riksbank in its September meeting reiterated that there would be another interest rate hike by the end of this year or the beginning of next. This naturally caused a squeeze higher in SEK against the EUR and the USD.However, we struggle to see a catalyst for further sustained SEK appreciation, unless markets go into major risk-on mode. In that respect, our central scenario sees a stabilisation of EURSEK close to 10.70: the main tailwind is valuation (SEK is very cheap) but headwinds are plenty, including a slowing economy and a still-uncertain outlook for global trade, both of which are likely to lead the Riksbank to shift to a more dovish stance.

15. NOK has been under pressure since mid-July All in spot terms


16. EURNOK about 5% higher than implied by rates and oil In spot terms


17. Swedish underlying fundamentals have deteriorated markedly Underlying CPI is calculated using fixed mortgage interest rates


8.4

8.6

8.8

9.0

9.2

9.5

9.6

9.7

9.8

9.9

10.0

10.1


EURNO K USDNO K, RHS

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

Jan-10 Jan-12 Dec-13 Nov-15 Oct-17 Sep- 19

EURNO K, actu al

EURNO K, implied by rates and oil price

90

95

100

105

110

115

1.0

1.4

1.8

2.2

2.6

Dec-16 Jul-17 Jan-18 Aug-18 Feb-19 Aug-19

CPI u nderlying, YoY, %

Economis tendency survey, RHS

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Commodity FXPositive on AUD and CAD

· AUD has depreciated sharply on a multi-month basis, setting the stage for a rebound

· We remain constructive on the CAD; expectations of material BoC easing run the risk of disappointment, while US-CA rate differentials suggest CAD upside

· We maintain our relatively neutral stance on NZD, struggling to see a catalyst for a move in either way

AUD has depreciated sharply on a multi-month basis: since early 2018 it has lost just over 17% of its value against the dollar and, despite its September rebound, it is still trading close to its lowest level since 2009 (see chart 18). Although upside for traditional risk assets such as equities appears limited – a headwind for cyclically sensitive and externally exposed currencies like AUD – we believe plenty of the bad news is already in the price. US-China trade disputes remain at the forefront, but given the AUD depreciation so far, this is more likely to act as a restraint to significant appreciation rather than a source of sustained downside pressure.In line with dollar overvaluation, AUDUSD is around 10% undervalued based on our estimates, a deviation which in the past has triggered a mean-reverting pattern in subsequent quarters. Additionally, we maintain the view that the market is pricing too much monetary policy easing. On a 1Y ahead basis, the rates market has priced in two additional 25-bps cuts (which would bring the cash rate to 0.5%, its lowest level ever), with a return to normalisation not seen before three years out. This appears too stretched to us, especially when domestic labour market conditions remain supportive. Although the unemployment rate has edged a touch higher recently, job additions so far this year are running above the average since 2000, and are predominantly driven by gains in full-time employment (see chart 19). Moreover, the speculative market is still quite short, increasing the risk of a “short-squeeze”. In a nutshell, we think it is reasonable to expect only one more rate cut which would come as a disappointment to AUD bears.Turning to Canada, the CAD has managed to pare back some of the losses it experienced in July and August. We see two reasons behind this stabilization: first, August job gains (released on 6 September) showed an increase of more than 80k, surpassing expectations by a wide margin. Second, the trade-weighted USD is down by 1% in September, and USDCAD (being sensitive to dollar moves) has moved a bit lower accordingly. The recent oil price spike has also helped.Going forward, we remain constructive on the CAD, expecting a gradual USDCAD depreciation. The market is still looking for easier monetary policy stance, although the economy operating close to potential and inflation on target suggest that there is a material risk for disappointment, especially with the labour market performing so solidly.

18. AUD on a multi-month depreciating path All in spot terms


19. Australian labour market looking OK


90

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AUDUSD TW AUD, RHS

-20

-10

0

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2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Employment change total, '000sEmployment change full time, '000sEmployment change total, '000s, average since 2000

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Moreover, both the current level of oil prices as well as the US-Canada 10Y yield spread reveal that USDCAD is still too high relative to fundamentals (see chart 20). On balance, we see rate cut(s) as a much closer call than the market is positioned for and expect further USDCAD downside.Finally, in New Zealand the NZD rebounded in early September against the USD before falling again over the past week. We see no catalysts for a sustained move either way.Manufacturing confidence has deteriorated rapidly while inflation remains muted, despite central bank RBNZ having cut interest rates twice this year to 1%. Although there are a number of similarities in that respect with Australia, the main differences are (i) the market is expecting less easing by the RBNZ compared to its Australian counterpart the RBA, hence the scope for disappointment is narrower, and (ii) from a valuation standpoint, NZD is much closer to fair value compared to the AUD. We maintain our forecast trajectory unchanged, i.e. flat around 0.63 over the next few quarters.

Commodity FXPositive on AUD and CAD

20. USDCAD too high relative to US-CA rate spread USDCAD in spot terms


0

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USDCAD US-CA 10Y yield spread, % , RHS

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Our Lombard Odier long-term FX fair valuation framework

DefinitionEconometric model, which estimates FX fair values by “mapping” the exchange rate to a set of fundamental economic variables

DefinitionFramework tries to identify the level of the exchange rate that would bring the

economy into macroeconomic equilibrium (Current account balance

sustainably financed by flows)

OutputFair value estimates for major forex crosses Updated 2 to 3 times annually Weight: 50%

UsageAnchor for long-term forecast

Output Fair value estimates for major FX crosses

Updated 2 times annually Weight: 50%

Usage Degree of misalignment can be a

sell or side signal

COMBINED OUTPUT – LO FX long-term fair value estimates

Inputs· Terms of trade

· Investment as % of GDP

· Current account

· Capital flows

· Rate differentials

· Inflation differentials

· Price elasticity of trade

· Output gap

BEERBehavioural equilibrium exchange rate model

FEERFundamental equilibrium exchange

rate model

101010 100010 110011

101010 100010 110011

0101 0010 1001 0110

0101 0010 1001 0110

Inputs

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Please read important information at the end of the document.Lombard Odier · FX Monthly · September 2019


Glossary

1W1-week

BEERBehavioural Equilibrium Exchange Rate – one method for evaluating the fair value of a currency.

BISBank for International Settlements

C/ACurrent account

CFETSChina Foreign Exchange Trade System.

CFTCCommodity Futures Trading Commission

EMEmerging market(s)

FEERFundamental-equilibrium exchange rate – rate consistent with a steady economy at full employment and a sustainable current-account balance.

RTReal time

TWTrade-weighted (dollar, etc.)

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