Currencies and alternatives
FX: Steady as she goes
Central banks are on hold, keeping cross-currency exchange rates in check. It would take surprises (a no-deal Brexit hit to sterling) or market shocks (safe-haven buying of the yen) to break currencies out of current ranges. The euro should remain range bound versus dollar. Stimulus measures in China and steady demand should prop up cyclical commodities (oil, copper). Hedge funds could face higher volatility and we prefer those strategies which perform best in turbulent markets.
Currencies: little further upside for the dollar
Dollar rally petering out
The Federal Reserve (Fed) has paused its policy normalisation, implying that interest rate gaps with other major currencies could stabilise as growth differentials narrow this year. Markets face looming dollar headwinds, such as widening twin deficits, and Russian and Chinese moves to diversify away from the USD for both trade settlement and official reserves. In addition, long dollar positions on futures markets are stretched. Although political risks may bolster the dollar near term, the catalysts for a further leg up are missing. We expect the dollar index to trade range bound in the months ahead.
Moving in concert
We see limited downside risks for the euro against the USD at current levels. The European Central Bank (ECB) has hinted at easing measures, but these should be mostly designed to ease funding conditions to boost growth. Cheap valuations and the eurozone’s large current account surpluses are also supportive. However, there are persistent headwinds – macro data have been disappointing and political risks endure.
Sterling’s fate is driven by market sentiment on Brexit. We expect a soft-Brexit outcome, and hence a modest uptick in the pound, though possibly after the March 29 deadline if it is extended.
A late cycle bounce in commodities
Rebound in oil prices should continue
After plunging in Q4 2018, oil prices are now recovering thanks to the Fed’s softer tone, improving market sentiment and production cutbacks by OPEC and its allies. We still see upside potential in the short run as global oil demand is trending upwards, the rise in US shale oil output has stalled, and production in Iran and Venezuela has contracted. We expect oil prices to trade in a $65-70 range later this year given supply/demand dynamics.
Gold prices set to consolidate
The recent gold rally seems overdone. Although the rally was sparked by late-2018 risk aversion, it has continued despite improving sentiment. US real rates (that is, net of muted inflation) have crept up, increasing the opportunity cost of holding gold, a non-yielding asset. We think a correction is possible as gold has been trading close to $1350/oz, its high over the past three years. Our target remains at $1250, but we continue to hold it as a safe-haven asset.
Copper requires some patience
Copper inventories are low, geopolitical risks should fade as US-China trade discussions advance and Chinese imports of copper ore have increased – all supportive factors for prices. Chinese stimulus measures are already reflected in accelerating credit growth and increases in infrastructure spending are expected – prices should pick up later this year.
Hedge funds: Overweight, but be selective
Prefer Merger Arbitrage type strategies
Hedge funds can help in unstable market conditions, but selectivity is key. Several strategies suffered drawdowns in 2018 (Long/Short Equity, Special Situations, CTAs or trend- followers), while others proved more resilient (Merger Arbitrage, Fixed Income Arbitrage, Global Macro). We prefer strategies which hold their own in bear markets, such as Merger Arbitrage.
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.