Little to go for
As global interest and GDP growth rates begin to converge in the second half, we see little reason for sizeable swings in currencies. The big exception to this view is Sterling, which is subject to extreme swings given the twists and turns of Brexit.
Dollar Index. The dollar has had a number of key supports in recent years. Interest rates are higher than elsewhere, growth has been more robust and the depth and quality of US capital markets continues to attract portfolio flows. Despite all these positives, the Dollar Index – which measures its international value against peers – has been tracking sideways since late last year. This reflects the fact that the dollar is now expensive and already well-represented in reserves and portfolios. Shrinking differentials in rates and growth could begin to erode some of its strength.
EURUSD. There remain numerous headwinds in Europe, from Brexit to ballooning budget deficits in Europe, from potential US auto tariffs to rising political divergences between EU members. Moreover, euro zone exporters have struggled in recent quarters, slowing growth across the region and prompting the central bank to prepare the ground for looser policy. However, the ECB has much less room to ease than the Fed and the euro is rather undervalued against the dollar. All in all, we see range-bound trading for now.
GBPUSD. Sterling is trading at historically low levels (£1 = ca. $1.21) and is significantly undervalued versus the US dollar on most measures of purchasing power parity, a proxy for “fair value”. However, the currency is clearly not trading on fundamentals, and volatility levels in Sterling are above that of some notable emerging markets. The biggest driver in the short-run is the market perception of three broad possibilities: A) Hard Brexit (i.e. no deal); B) Soft Brexit (i.e. a deal); or C) some other outcome (e.g. a general election or a delay).
It is impossible to know which one of the three options is more likely at this stage, though the market is rife with speculation and the currency is highly sensitive to news flow. Evidence suggests attempting to divine geopolitical outcomes, or subsequent market moves, is largely a fruitless pursuit. Our approach is to ensure we are comfortable with risks to globally oriented, multi-asset, Sterling-referenced portfolios. Should further Sterling weakness occur, these strategies should benefit. Should Sterling strengthen, globally oriented strategies should face a currency drag; thus we “hedged” part of the non-Sterling exposure earlier in the year and may do so again should Sterling fall further.
USDJPY. The Bank of Japan will find it difficult to match Fed policy easing, meaning a shrinking interest rate differential which could bolster the yen. Moreover, the yen is modestly undervalued and also prized as a safe haven in times of trouble. A VAT-hike induced recession could exert some downward pressure, but this is likely to be short-lived.
EM currencies. They have shown notable resilience lately, despite slowing economies and trade war worries. Over recent years, many emerging economies have ditched their explicit pegs to the dollar, bringing greater monetary policy flexibility along with freer-floating currencies. However, recent rate cuts – South Korea, Indonesia and South Africa all eased on July 18 – mean the EM currency index could remain low against the dollar.
USDCNY. A slowing domestic economy and trade war headwinds has led the renminbi to weaken beyond the psychologically important CNY 7 versus the US dollar. However, the authorities will be keen to stem capital outflow risks and also to promote increased use of the CNY for trade settlement. This means a delicate balancing act which is likely to see the CNY trade sideways in coming months.
Despite its cheap valuation, there remain numerous headwinds for the euro. We see range-bound trading this summer.
|Sterling is sharply undervalued, but the political backdrop is likely to delay any meaningful recovery.|
Risks on both sides of the English Channel will keep the cross-rate steady.
The yen is modestly undervalued and prized as a safe haven. However, A VAT-hike induced recession could exert some downward pressure.
|EM currencies have shown resilience despite trade war. However, several EM central banks have commenced easing and their currencies could remain weak against the dollar for now.|
Source: Kleinwort Hambros 07/08/2019
*Duration: short = Up to 5 years, medium = 5-7 years, long = 7+ years
Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.