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The USD gained in May with indications that the Iran conflict would actually be a prolonged one, with multiple attempts at closing an MOU failing, though the INR saw sharp appreciation with heavy intervention. We continue to see fiscal dominance ahead, with the Fed and BOJ most compromised, driving mild depreciation in the USD and JPY, while limited Eurozone and UK positives limit moves. We continue to see more nuanced CNY appreciation ahead, with recovery in CPI inflation muting pressures. On the INR, recent steps do not change the flow equilibrium, implying continued mild depreciation ahead.
USD rises in May on longer West Asia conflict
The broad USD was mixed in the first week, with chatter of a US/Iran one-pager, though the second week saw strong buying with no deal being signed and indications of fresh kinetic action. The third week saw markets settle, though aggressive RBI intervention at this point brought strong INR appreciation. The fourth week saw fresh USD supply on messaging of an Iran deal being done amid moves towards signing of an MOU to set a 60 day negotiating period around nuclear matter. The week also saw the GBP weaken on political concerns, but these faded with hopes of EU reunification, while the JPY was seen inching towards the 160 level. The CNY continued to see pushback against appreciation.
Continue to see mildly weaker USD, JPY and INR
We continue to expect the USD to weaken after the West Asia conflict fades. We see the Fed and the BOJ as compromised, driving weakness in the USD and JPY, though slack in the Eurozone and UK will limit hikes and flows, limiting the overall USD weakness. We also see the CNY appreciating slowly given higher inflation. Even with recent measures, we continue to see the underlying equilibrium for INR negative, keeping trends towards mild depreciation.
Putting it all together
We therefore persevere with our view of the EUR testing 1.20 again in the medium term, with fair value of around 1.18, while the GBP is expected to move on both sides of 1.35. The JPY is likely to test 165 in the medium term, though this move will be fought bitterly through intervention including hawkish comments from BOJ speakers. The CNY is likely to appreciate towards 6.70 in the year ahead. Lastly, despite heavy RBI intervention, the path to 100 on the INR remains alive unless strong actions are taken by the government. Anecdotes of things moving on the ground are heard, though a distinction will have to be made for measures merely boosting sentiment as against those changing the fundamentals through BEER - these would include increased asset supply, more fiscal spending, higher interest rates, or a larger supply of domestic assets.
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