Euro Area

U.S. inflationary forces remain tame, forcing the Fed to maintain an easy bias. Yet, the global economy is improving. This confluence could weigh on the dollar and boost commodity currencies. The NZD has more upside, but it will lag petro currencies. The BoJ will act, but timing is uncertain. Keep a negative bias toward the yen. CAD/NOK has more downside.

More aggressive monetary and fiscal stimulus will be necessary to resuscitate the Japanese economy. While the BoJ's forthcoming review is likely to endorse the current policy stance, there is a good chance that Kuroda will open the door to more radical measures. These measures will push down the yen, giving Japanese stocks a lift in the process. Sentiment on the U.K. economy has gotten too bearish. We are closing our short GBP/SEK trade and going long GBP/JPY.

The euro area's NPL problem is unlikely to be solved quickly, constraining bank profitability and the capacity to lend. There are three important repercussions for investors.

The tailwind of better-than-expected global growth and highly supportive monetary policy has the potential to push global spread product into overshoot territory.

While the BoE and the Fed are increasingly committed to letting inflation expectations rise, the BoJ disappointed once again. The dollar and the pound are likely to experience broad weaknesses, while gold, the euro and commodity currencies have upside. USD/ZAR will fall further in the short term, but the cyclical bull-market is not over.

Government bond markets have likely overestimated the degree of policy dovishness that is likely to be delivered by the major central banks in the next few months.

In July, the model outperformed both global equities and the S&P 500 in local-currency terms, while underperforming in U.S. dollar terms. For the monthly of August, the model made no changes to overall risk exposure.

The U.S. and the global economies are improving. A synchronized upswing normally trumps the Fed in determining the path for the dollar. U.S. inflation expectations are likely to rise relative to the rest of the world, weighing on the dollar. The risks for EUR/USD have risen. We are hedging our long EUR/USD position by shorting the euro on some crosses. Buy CHF/JPY.

The contours of a deal to solve Italy's banking problems are starting to emerge. This is good news for European risk assets. Nevertheless, reviving Italian growth will require even more ECB easing. The appetite for radical measures is low at present, but this will change if euro area growth remains lackluster and efforts by Japan to introduce helicopter money policies prove successful.

The recent rally in risk assets is walking a very fine line. If the Fed turns more hawkish, or U.S. growth slows, it could fall over.