Posted by Ray Uy, Head of Macro Research and Currency Portfolio Management on March 8, 2019, in Fixed Income
US dollar: Underweight
We continue to expect the US dollar to weaken against a backdrop of renewed global growth convergence. This will likely be driven by the unwind of the US exceptionalism theme of 2018 and the pivot toward a more dovish Federal Reserve policy going forward. Additionally, US budget and current account deficit concerns will likely persist and could be negative for US dollar performance.
We are optimistic on the prospects for euro appreciation given our bearish US dollar outlook. Valuations and investor positioning remain supportive for a modest recovery in the euro, in our view. Brexit developments and Italian headlines remain a headwind.
The renminbi traded in a range of 6.70 to 6.80 in February.1 We expect US dollar performance against other major currencies and US-China trade relations to continue to drive renminbi performance versus the US dollar in the near term. Capital market performance and China's inclusion in certain indexes may encourage more capital inflows into China. Our base case assumes the exchange rate will remain between 6.60 and 6.80 in the near term, unless unexpected developments emerge from trade talks or the US dollar strengthens.
Japanese yen: Overweight
The yen depreciated in February. Better risk sentiment and lower asset volatility has reduced demand for "safe-haven" assets despite generally weak economic data and lower global yields. Nevertheless, we view the yen as an attractive hedge for risk assets given attractive long-term valuations and still favorable positioning.
British pound sterling: Overweight
Although the March 29 Brexit date is approaching, a "no deal" Brexit remains a remote possibility, in our view. We believe it is more likely that Prime Minister Theresa May will get an adjusted version of her deal through the UK Parliament, probably entailing a short delay to Brexit. Failing that, a longer-term extension to UK membership in the European Union (EU) will likely be proposed by the EU. This could lead to a wider range of possible outcomes, from a "softer Brexit," including a permanent customs union with the EU, to a possible general election and/or referendum. In the near term, the removal of the "no deal" tail risk could present some modest upside for UK assets.
Canadian dollar: Neutral
We expect the Canadian dollar to continue to trade in a tight range in the near term. It has rallied from its December 2018 lows but has remained range-bound so far in 2019. The Canadian dollar has likely benefited from recovering oil prices and strong employment, a combination that has offset headwinds from the country's housing slowdown and higher consumer interest rates. Following a somewhat dovish shift from the Bank of Canada, market expectations for the next interest rate hike have been pushed out into 2020.2
Australian dollar: Neutral
The Australian dollar depreciated in early February in response to the Reserve Bank of Australia's increasingly dovish stance. However, the currency has recouped much of its losses, supported by buoyant commodity prices and improved sentiment regarding Chinese growth. Sentiment has also been boosted by reduced US-China trade tensions. The range-bound price action reflects the mixed drivers of the Australian dollar - domestic factors point to a weaker currency, while global (especially trade-related) factors suggest undervaluation at current levels.
Indian rupee: Neutral
The rupee has remained volatile in recent months, largely following movements in oil prices. Going forward, we believe risks are tilted to the downside, given policy uncertainty and a somewhat rich valuation level. Despite our relatively downbeat view of the rupee, we remain neutral as external factors, such as oil prices or the US dollar, could influence its performance.
1 Source: Bloomberg L.P., data from Feb. 1, 2019 to Feb. 22, 2019.
2 Source: DailyFX.com, "USDCAD soars after Bank of Canada strikes a dovish tone," Peter Hanks, March 6, 2019
Blog header image: Paul Brady Photograpy/Shutterstock.com
Dovish refers to an economic outlook which generally supports low interest rates as a means of encouraging growth within the economy.
The current account records a nation's transactions with the rest of the world - specifically its net trade in goods and services, its net earnings on cross-border investments, and its net transfer payments - over a defined period of time, such as a year or a quarter. A positive current account balance indicates that the nation is a net lender to the rest of the world, while a negative current account balance indicates that it is a net borrower.
Risk assets are generally described as any financial security or instrument, such as equities, commodities, high-yield bonds, and other financial products that carry risk and are likely to fluctuate in price.
Safe havens are investments that are expected to hold or increase their value in volatile markets.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
In a "no-deal" or "crash out" Brexit, the UK would leave the EU in March 2019 with no formal agreement outlining the terms of their relationship.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.