Range-bound trading for the dollar
The US dollar has risen over the course of the year, but inflation and growth expectations have fallen recently. Europe appears beset by anaemic growth and low inflation, with ECB likely to cut its base rate by at least 10 basis points in September. Sterling is significantly undervalued, but clearly not trading on fundamentals.
Dollar Index. The US dollar has risen this year versus its main trading partners. Initially USD strength was due its better inflation and growth profile coupled with higher rates. However, over the Summer as trade tensions spiked, it was safe-haven buying which bolstered the dollar. Yet inflation and growth expectations have fallen in the US too, and the Fed cut rates in July following a long string of hikes. Further cuts are expected and US 10-year government bond yields have fallen precipitously from above 2% a month ago to under 1.5% now. All in all, the picture remains mixed, and we expect choppy range-bound trading.
EURUSD. Europe appears beset by anaemic growth – especially in manufacturing – and low inflation. The European Central Bank (ECB) is likely to cut its base rate by at least 10 basis points in September and has signalled it will reverse its seven-month hiatus on its quantitative easing program. However, there is a limit to what the ECB can do – rates are already negative (-0.40%) and it is already the owner of nearly a third of all government debt. We see range-bound trading for now.
USDJPY. The Japanese yen is prized as a safe haven in times of trouble, which explains its strong outperformance versus the USD in August (~2%). However, the BOJ is still in active “loosening” mode. We expect the currency to remain range-bound for now, though it could strengthen should there be a big negative shock in markets (e.g. worsening trade scenario).
GBPUSD. Sterling is trading at historically low levels (£1 = ca. $1.21) and is significantly undervalued versus the US dollar on most valuation measures. However, the currency is clearly not trading on fundamentals – rather, it is all about “Brexit”. In the short-run, there are 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 outcome is more likely at this stage, and volatile trading is likely to continue.
Our primary goal is not to guess the direction of the currency based on unknowable geopolitical factors, but rather to ensure we are comfortable with risks to globally oriented, multi-asset, Sterling-referenced portfolios. Should further Sterling weakness occur, our portfolios currently stand to 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.
EM currencies. The broad emerging currency index has plumbed new depths this summer. On one hand, trade war escalation has pressured currencies such as the Chinese yuan. On the other, broad dollar strength has proved painful for indebted economies such as Argentina. All in all, we would not expect a recovery in EM currencies until the global outlook improves.
USDCNY. A slowing domestic economy and trade war headwinds have 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, especially as foreign currency reserves remain static at about $3 trillion, well below the $4 trillion record reached a few years ago.
The European Central Bank (ECB) is likely to ease in September. However, there is a limit to what the ECB can do. We see range-bound trading over the next months.
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 political and weak manufacturing sector on the other – will keep the exchange rate steady.
The Japanese yen is prized as a safe haven in times of trouble. However, the BOJ is still in active “loosening” mode.
The broad emerging currency index has plumbed new depths this summer. All in all, we would not expect a recovery in EM currencies until the global outlook improves.
Source: Kleinwort Hambros 04/09/2019
*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.