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BNP PARIBAS MARKETS CALL Summary

Core Content

This document provides a weekly cross-asset market view by BNP Paribas Markets Call, focusing on the US dollar's strength and its implications across different asset classes and global markets. It outlines the current state of the dollar, its drivers, and future outlook, along with key market positioning and investment strategies.

Main Views

• Dollar Dominance: End in Sight?
  The dollar's strength is primarily driven by a strong US economy relative to the rest of the world and divergent central bank policies. While the dollar is expected to remain strong in the short term, medium-term factors such as narrowing rate differentials and a fading fiscal impulse may lead to a weakening of the USD. In the long term, the RMB's internationalization could challenge the dollar's dominance.

• EURUSD and GBPUSD: Market Positioning and Outlook
  The market is currently long USD against EUR and GBP. Political uncertainty in Europe and the UK, particularly related to Brexit, is expected to continue influencing the euro and pound. The EURUSD is projected to rise in 2019 due to improving balance of payments, while GBPUSD is expected to rise above 1.45 in the second half of 2019 if Brexit is smooth. However, a 'hard Brexit' could lead to significant depreciation of the GBP.

• FX Hedging Costs and Portfolio Flows
  FX hedging costs have increased for Japanese investors, making US bonds more expensive and affecting investment flows. Portfolio inflows from Japan into Europe have risen, suggesting a shift in investment preferences. However, these flows may reverse if the USD weakens against the JPY.

• Emerging Markets (EM) and RMB Internationalization
  EMs are negatively affected by a strong USD and a weaker RMB, which reduces their export competitiveness. The RMB is gaining international traction, with its use in non-dollar commodity futures increasing. However, the RMB is still far from becoming a major reserve currency.

• Interest Rates and Economic Growth Differentials
  The growth differential between the US and other economies is a key driver of the dollar's strength. As this differential narrows, the dollar's appeal may diminish. The CLEERTM model highlights the importance of balance of payments and macroeconomic fundamentals in determining fair value for currencies.

• Market Volatility and Investment Strategy
  The document highlights the potential for increased volatility, especially around the Brexit negotiations. It recommends a GBPUSD strangle strategy with strikes at 1.2550 and 1.3495, expiring on 30 Jan 2019, for investors who agree with the outlook.

Key Information

• Dollar Strength Drivers:

  • Strong US economy relative to the rest of the world
  • Divergent central bank policies
  • Geopolitical tensions, including trade disputes and political instability in Europe

• Dollar Weakness Indicators:

  • Expected end of the Fed's hiking cycle
  • Fading fiscal impulse
  • Weakening demand for US assets from international investors
  • Large non-petroleum trade deficit

• Eurozone Outlook:

  • Political risk in Europe is a major factor influencing the euro's value
  • EURUSD is expected to rise due to improving balance of payments
  • Political uncertainty could cause EURUSD to diverge further from its CLEERTM fair value

• GBP Outlook:

  • Political uncertainty surrounding Brexit continues to affect GBP
  • A 'soft Brexit' is the base case, with GBPUSD expected to rise
  • A 'hard Brexit' could lead to a significant decline in GBP
  • Only a small likelihood of a 'no deal' scenario is priced into GBP

• Investment Strategy:

  • Recommended trade: Buy a GBPUSD strangle with strikes at 1.2550 and 1.3495, expiring 30 Jan 2019
  • The trade is expected to yield a 1.62% return
  • Short-dated options are preferred to minimize premium costs in a high-volatility environment

Summary Table

Key Contributors

• Robert McAdie - Chief Cross Asset Strategist, BNP Paribas London Branch
• Pierre Mathieu - Senior Cross Asset Strategist
• Benedicte Lowe - Cross Asset Strategist
• Kris Gjini - Cross Asset Strategist
• Sam Lynton-Brown - Head of G10 FX Strategy, Europe
• Vasilis Koutsaftis - FX Options Strategist

Market Positioning Highlights

• FX investors are long USD vs EUR and GBP
• USD long positions are near historical highs
• EURUSD is currently oversold compared to macro fundamentals
• GBP is pricing only a small likelihood of a 'hard Brexit' scenario
• CLEERTM model suggests GBPUSD should rise to 1.40 over the next 12 months

Additional Notes

• CLEERTM Model: A medium-term model for determining fair value based on economic fundamentals
• STEERTM Model: A short-term model incorporating market factors to identify mispricing
• Risk Premia: Limited risk-reward is priced into GBP, suggesting a more positive outlook for the pound
• Volatility Outlook: High volatility is expected, especially around Brexit negotiations
• Webcast and Dial-in Details: Available at the back of the document for further insights and participation

Conclusion

The document outlines a cautious outlook for the dollar, with short-term strength but medium-term weakening due to various economic and political factors. It emphasizes the importance of balance of payments, growth differentials, and geopolitical risks in shaping currency values. The recommended GBPUSD strangle strategy is presented as a way to capitalize on potential market movements.