FX Monthly – Our high conviction views

by: Georgette Boele

140110-FX-Monthly.pdf ()

Dollar to outperform

In this monthly, we give an update on our high conviction FX views. We remain of the view that the dollar will strengthen broadly. This reflects cyclical factors such as our above-consensus expectations for both US economic growth and the number of Fed rate hikes next year. Given strong growth and real interest rates moving into positive territory, US assets are becoming more attractive. The strong positive correlation between the US dollar and both US Treasury yields and the Dow Jones Index suggests the dollar is ready for a cyclical lift. Overall, the improvement in investor sentiment is likely to support the dollar. Meanwhile, structural factors, such as the budget and current account balances, are also improving, while the currency is undervalued.

Euro strength unlikely to last

The euro has been resilient over the last few weeks, but we think this is set to change. Further monetary easing is a distinct possibility from the ECB, given that inflation is set to get stuck at very low levels. The eurozone economic recovery will also be comparatively slow. Monetary policy and growth divergences should become increasingly more apparent, which should favour the dollar and sterling against the euro.

Chinese yuan’s modest appreciation to continue

The liberalisation of China’s capital account is likely to progress in the coming years. The CNY will be supported as trade settlement in the currency increases and FX reserve allocation into the CNY rises, given its potential role as a reserve currency. China’s large current account surplus and foreign exchange reserves are other positive attributes. As China’s financial reforms continue to roll out, an adjustment of the CNY trading band in the course of this year seems likely. A widening of the band will allow the CNY to fluctuate in a more orderly way.

More widely we favour positioning in favour of global growth, but against commodities and safe havens

We favour the Swedish krona versus the euro, because it could benefit from an upswing in the Swedish economy. We judge that the market is currently too pessimistic on the outlook for economic growth and monetary policy. Sweden is more sensitive to the global cycle and interest rates, has a lower exposure to commodities compared to the Norwegian krone and has a relatively attractive valuation. Turning to emerging markets, we expect currencies with a substantial exposure to global trade and the US economy and that yield attractive returns to do well. We are therefore positive on the Korean won (versus Asian currencies), Mexican peso and the Polish zloty. We are negative on commodity currencies, including the Australian dollar and the Canadian dollar and safe haven currencies, namely the Japanese yen and Swiss franc.