UBS released a report on the current foreign exchange environment, maintaining its key G10 currency views and predicting continued strength for the U.S. dollar. The firm highlighted that despite markets reducing the extent of priced-in policy divergence, there was no compelling reason to change their outlook.
Equities and risky assets are still performing well with low and falling near-term implied volatility, suggesting the dollar should hold its own over time due to ongoing yield backing.
The firm observed that the dollar appears to be undershooting front-end rates, particularly after the post-CPI yield move was largely retraced, while the DXY has reversed less than 50% of last week's sell-off.
UBS noted that recent comments from Federal Reserve speakers did not indicate a shift in policy based on the April inflation print, which could mean the Federal Open Market Committee (FOMC) might not cut rates in September as currently expected by the market.
UBS also discussed the viability of carry trades as a means to diversify from pure USD exposure, recommending to avoid shorting the EURUSD pair directly, even though it is within what UBS considers a "sell zone." Instead, the firm is focusing on Swiss Franc (CHF) crosses such as USDCHF and AUDCHF.
UBS anticipates that the market has not fully priced in two more rate cuts by the Swiss National Bank (SNB) that they expect for the rest of 2024.
The broker commented on the Japanese Government Bonds (JGB) yields, which have approached the 1.00% level for the first time since 2012. UBS remains skeptical about a significant hawkish move from the Bank of Japan (BOJ), maintaining a target of USDJPY at 160.00 by year-end and viewing dips towards 152.00 as a buying opportunity.
Lastly, UBS discussed the Canadian April CPI report, which supports the view of a potential rate cut by the Bank of Canada (BoC) in June—a view not fully priced in by the rates market. The firm holds onto its bullish USDCAD view, maintaining a 1.38 vanilla call option.
UBS suggests that the reduced short CAD positioning and lower implied volatility could increase the attractiveness of expressing dovish Canadian views via the FX market.
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