We have turned tactically positive on the yen on safe-have appeal, but are now negative on the more cyclical and commodity-linked currencies such as the Australian dollar, the Canadian dollar, the New Zealand dollar and the Norwegian krone.
The bank failures in March have increased the chances of credit tightening and a recession led by the US later in 2023. This likely skews yields, equity markets, and credit to the downside, and shifts the currency market outlook. More defensive currencies such as the yen and the euro are likely winners, while more cyclically sensitive currencies—such as the Australian dollar, the New Zealand dollar, and the Norwegian krone—would likely suffer. The US dollar is stuck in the middle, and might lose its usual role as the preeminent safe haven, but is still likely to outperform those highly cyclical currencies if growth and equity markets falter, as we expect.
For long, we have called for a bumpy ride for currencies in 2023 (“Bumpy Ride for Currencies in 2023?”). The banking stress and the volatility of March are perfect examples of that path. We expect more of the same throughout the year—hopefully with few bank failures. We see economic resiliency, in the face of this uncertainty and the likelihood of further monetary tightening, as a key driver of currency markets over the next several months, but are under no illusions that the risks are confined to the US; they are global.
Figure 2: March 2023 Directional Outlook
Bumpy Ride for Currencies in 2023?
Aaron R Hurd on currencies, inflation and economic outlook
Aaron R Hurd on currencies, inflation and economic outlook
“We see a bumpy ride for currencies through 2023 and perhaps into 2024. We expect greater volatility and some retracement of the sell-off in US dollar. More pro-cyclical currencies are likely to suffer the steepest pullbacks.”
We believe that the failure of Silicon Valley and Signature Bank will hasten the outflow of banking deposits, encourage banks to increase capital buffers, and result in tighter US credit conditions. That, in turn, means that the US is likely to lead the global economic slowdown and eventually the reversal of monetary tightening to the detriment of the US dollar. However, we see room for a near-term rebound in both short-end US yields and the US dollar after the extreme weakness in March. Beyond that, we favor expressing short US dollar views vs. the euro and the yen given their lower sensitivity to equity market weakness and the potential for their central banks to tighten policy after the Fed pauses.
Our models are negative on the Canadian dollar on weaker commodity price trends, poor relative local equity market performance, and expectations of a deeper economic slowdown. Also, Canada and the Canadian dollar are heavily exposed to the weakening US growth outlook. However, recent economic data in Canada have been surprisingly resilient and the immediate impact of lower US yields benefits the Canadian dollar against both the US dollar and the more cyclically sensitive Australian dollar, New Zealand dollar, and Norwegian krone.
We are positive on the euro on an improving economic outlook powered by the lower-than-expected energy prices and decent fiscal spending. Meanwhile, the stubbornly high core inflation is likely to keep the European Central Bank on a tightening path, while the Fed and a number of other G10 central banks have stopped, or will soon stop, tightening policy. The euro is also likely to benefit from its relatively low correlation to global equity volatility, which makes it less sensitive to risks that global monetary tightening will trigger a recession.
Better-than-expected recent growth data and a reasonably well-capitalized banking system helped the British pound weather the volatility in March. But we believe it will be increasingly difficult for the pound to extend recent gains due to the weak economic outlook, the Bank of England’s cautious policy tightening, global growth risks, and a lingering (large) current account deficit.
In the long term, the pound is extremely cheap vs. the euro, the US dollar, the Australian dollar, the Swiss franc, and the Canadian dollar, though it is unlikely to realize its potential until inflation is under control and UK growth turns sustainably higher.
The Japanese yen reclaimed its historical role as the preeminent safe-haven currency, rising sharply during the mid-month banking crisis, a role it is likely to fill going forward if our expectations of declining growth and fragile equity markets prove true. On top of the safe haven, relative interest rate differentials favor the yen as global yields fall from their highs. The yen should also find support as low unemployment, stronger-than-expected wage gains, and a continued rise in core inflation increase the chance of the Bank of Japan tightening monetary policy later this year.
We are neutral on the franc in the near term. The currency remains expensive in our estimates of long-run fair value, and growth data continue to soften, both of which point to a lower franc. These negative drivers are largely offset by lower yields across the G10, which improve relative Swiss interest rates. In addition, the Swiss National Bank should be incentivized to intervene in currency markets to maintain a strong currency rather than depend on interest rate increases to contain inflation as higher rates may put further stress on Swiss banks.
We expect the Norwegian krone to struggle on weak/volatile oil prices, a recent slowing in domestic growth, and a higher risk of global recession following the banking sector stress in March. The krone is highly sensitive to equity markets, and we expect further downside pressure on the currency as we expect periods of higher volatility this year.
In the longer term, the Norwegian krone is historically cheap relative to our estimates of fair value and is supported by steady potential growth. Thus, we expect strong gains eventually, but reiterate that the krone faces a tough near-term environment.
We are close to neutral on the Swedish krona. The recent hawkish shift by the central bank and ongoing positive inflation surprises are supportive, but the Swedish krona may continue to struggle for a number of reasons: namely, falling home prices, soft growth data, and the risk that the central bank fails to back up its hawkish comments with more aggressive policy tightening.
From a long-run perspective, the krona is significantly below its long-run fair value and has ample room to rally, though we do not see a ready catalyst for krona appreciation so long as economic data and the global outlook remain challenged.
Weak/choppy commodity prices, slowing consumer activity, negative real wage growth, rising equity market risk, and a more cautious Reserve Bank of Australia present meaningful headwinds for the Australian dollar in the near term. We think that the Australian dollar downside may be limited as improved China growth begins to show up in the data. That said, we do not think that China growth will be enough to warrant outright Australian dollar strength, because it is likely to be concentrated in domestic services.
In the longer term, the Australian dollar outlook is mixed. It is cheap vs. the US dollar and the Swiss franc, and has room to appreciate but expensive against the British pound, the yen, and the Scandinavian currencies.
We are negative on the New Zealand dollar in the near term. High yields should help support the New Zealand dollar. However, that positive impulse is likely to be more than offset by weaker growth, fragile global risk sentiment, and downside risks to equity markets as global recession risk rises.
In the longer term, our New Zealand dollar outlook is mixed. It is cheap vs. the US dollar and the Swiss franc, and has room to appreciate, but fairly valued vs. the Canadian dollar and the euro, and expensive against the Australian dollar, the British pound, the yen, and the Scandinavian currencies.
State Street Global Advisors Worldwide Entities
Investing involves risk including the risk of loss of principal.
There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.
Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.
The views expressed in this material are the views of the Report Component Team through the period ended 31/03/2023 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
This document may contain certain statements deemed to be forward-looking statements. All statements, other than historical facts, contained within this document that address activities, events or developments that SSGA expects, believes or anticipates will or may occur in the future are forward-looking statements. These statements are based on certain assumptions and analyses made by SSGA in light of its experience and perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances, many of which are detailed herein. Such statements are subject to a number of assumptions, risks, uncertainties, many of which are beyond SSGA’s control. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
This communication is directed at professional clients (this includes eligible counterparties as defined by the “appropriate EU regulator”) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.
Past performance is not a reliable indicator of future performance.
Assets may be considered “safe havens” based on investor perception that an asset’s value will hold steady or climb even as the value of other investments drops during times of economic stress. Perceived safe-haven assets are not guaranteed to maintain value at any time.
© 2023 State Street Corporation.
All Rights Reserved.
Exp. Date: 30/04/2024