With GDP growth rates converging lower and key interest rates coming down across the globe, we expect sideways trading in foreign exchange markets. Valuation extremes - GBP cheapness, for example - are only likely to unwind in the longer term.
Dollar Index. Macro fundamentals have favoured the US dollar so far this year. GDP growth has been stronger than elsewhere while key rates and bond yields are much higher. However, the dollar index has only inched higher, +2.2% year-to-date. Part of the explanation lies in the tightening of differentials, as the Fed has embarked on a new easing round and growth has slowed. And part lies in relative valuations – the dollar is overvalued against peers, notably EUR and GBP. Looking ahead, the negatives should be offset by solid fundamentals, suggesting sideways trading.
GBPUSD. The parliamentary vote to block “no-deal” Brexit sparked a modest rally in sterling, but it was quickly reversed. Nonetheless, since the stinging rebuke of Prime Minister Johnson’s prorogation of Parliament by the Supreme Court, has since concentrated on finding common ground on the contentious Irish border question. However, uncertainty remains high – Brexit day could be delayed again, an early election is likely and the country remains divided between restive Remain and Leave supporters. While sterling is undervalued, Brexit news will dominate volatile trading around current levels for now.
Our primary goal remains not to guess the direction of the currency based on unknowable geopolitical factors, but rather to ensure we are comfortable with risks to multi-asset, Sterling-referenced portfolios. In globally oriented strategies, Sterling weakness will lead to positive performance, all else equal. Conversely, should Sterling strengthen, a currency drag will occur; thus we “hedged” part of the non-Sterling exposure earlier in the year and may do so again should Sterling fall further.
EURUSD. In surpassing market expectations, the ECB’s September raft of easing measures put some short-lived downward pressure on EURUSD. Moreover, Germany looks close to a second consecutive quarter of declining GDP, the textbook definition of a recession. However, fears of “no-deal” Brexit have eased for now and Italy’s new government looks more market-friendly, helping revive risk appetite, as has talk of fiscal easing. We expect no major move in EURUSD in coming months but some modest strength on a 12-month view.
USDJPY. The previous two VAT hikes in Japan have triggered recession and a third looms in October. Moreover, global industrial slowdown is bad news for many Japanese exporters. However, the JPY is viewed as a safe haven and tends to rally in times of trouble. We expect that these opposing forces will cancel out, leaving USDJPY close to current levels).
EM currencies. The broad emerging currency index has recovered modestly from early September’s dip, but remains down 2.3% year-to-date. The global trade slowdown and dollar strength have kept EM currencies at multi-decade lows, and weak links – such as Argentina and Turkey – have seen sharp devaluations. Despite increasingly attractive valuations, a meaningful rally is unlikely until global growth picks up.
USDCNY. As Beijing and Washington have made conciliatory gestures on trade in recent weeks, the Chinese authorities have let CNY strengthen modestly. However, the daily fixing rate for USDCNY remains well above the psychologically important CNY 7 to 1 USD level and it seems clear that China would not hesitate to allow further weakness if trade talks fail again. In the near term, we expect no big move in either direction.
We expect no major move in EURUSD in coming months but some modest strength on a 12-month view.
Sterling is trading at historically low levels and is significantly undervalued versus the US dollar. However, the currency is divorced from fundamentals, and clearly trading on Brexit news flow.
Risks on both sides – Brexit uncertainty on one hand and weak manufacturing sector on the other – will keep the exchange rate range-bound.
The global industrial slowdown is bad news for many Japanese exporters. However, the JPY is viewed as a safe haven and tends to rally in times of volatility.
Despite increasingly attractive valuations, a meaningful rally is unlikely until global growth picks up.
Source: Kleinwort Hambros 04/10/2019
*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.