Weaker-than-expected inflation and a dovish monetary policy shift boosted investor sentiment in July, with the NOK gaining 4% vs. the G10 average, while the USD declined 1.8%. But the markets are still in a fragile place, which will limit upside in risky assets and result in periods of support for safe-haven currencies such as the USD and the JPY. Tactically, we turn negative on the GBP and neutral on the CAD and the NOK.
There is strong momentum behind the positive move in risk assets currently supported by disinflation and the shift of major central banks toward a pause, or an outright end, to the policy tightening cycle. That risk-loving environment, if it continues, favors a weaker US dollar and yen against strength in more pro-cyclical currencies such as the Norwegian krone, the Swedish krona and the Australian dollar.
Our base-case outlook (“Favor USD, JPY as Stagnation Ahead,” 13 July 2023) is for a period of significantly-below-potential global growth through 2024. We already see stagnation across the UK and Europe, while China continues to disappoint expectations. We believe it is too soon to abandon caution and count out the defensive and high-yielding US dollar even if the US Federal Reserve (Fed) is done tightening monetary policy.
Figure 2: July 2023 Directional Outlook
We confidently believe that the next big, sustained move in the US dollar is lower – a broad decline of 10%–15% – but it appears a bit early for that now. US growth and yields are among the best in the G10 and the equity rally since October 2022 looks ripe for a correction at some point, leading to safe-haven demand for the US dollar (though that is very difficult to time). It is hard to bet against a defensive currency with high yields and growth. Once we get through, or are at least well into, a global slowdown and see the Fed actually begin to ease monetary policy, investors are likely to look forward to a more fundamentally sound global recovery catalyzing a sustainable US dollar downtrend.
We move our Canadian dollar view from negative to neutral as a result of improved commodity prices, decent yields and the ongoing positive economic data surprises, which offset relative weak local equity market signals. Its high correlation to the US dollar also makes it more attractive than other cyclical currencies, such as the Norwegian krone and the Australian dollar, if recession risk sours investor sentiment, though in that case the Canadian dollar may likely underperform the US dollar.
In the longer term, we think Canadian growth will remain competitive and the Canadian dollar looks cheap in our estimates of fair value relative to the euro, the Swiss franc, and the US dollar, creating room for further upside.
We are neutral to slightly negative on the euro in response to the steady stream of weaker economic data surprises and a more dovish European Central Bank (ECB) policy outlook. Any return of pessimism and equity volatility over the next few months would likely support the euro vs. higher-beta currencies, but a broad euro upside appears unlikely in the near future. ECB policy rates are middling relative to the rest of the G10, providing only limited yield support, while the risk of recession is rising as the ECB tightens monetary policy, adding headwinds to an EU economy that is already flatlining.
We shift to a tactically negative view on the British pound in response to decelerating economic data, very high inflation and poor UK equity market performance. Inflation risks becoming entrenched. Failure to tighten monetary policy sufficiently would risk Bank of England (BoE) credibility and drive the pound lower. Aggressive tightening in an economy that is already stagnant risks serious recession, sending the pound lower. And there is a high and growing risk that a recession may happen regardless of future BoE policy decisions. The path to further pound strength is very narrow.
The yen is likely to struggle in the near term given its negative short-term interest rates. But we see risks skewed toward a yen recovery later this year and through 2024. The yen is very cheap, and we expect global yields to turn lower along with a period of severely below-trend global growth as we head into the next year. This supports yen strength via improved yield differentials and safe-haven demand. Timing of these factors requires patience and tolerance for additional yen weakness. Nevertheless, we believe it makes sense to build a long yen bias now.
We are negative on the franc over both the tactical and strategic horizons. It is the most expensive G10 currency per our estimates of long-run fair value; growth data continues to soften; inflation is rolling over; and, aside from the yen, the franc has the lowest yields in the G10. Despite those negative forces, our pessimistic view on the franc will require patience. As we mention above, the recent deceleration in EU growth is a near-term support and the Swiss National Bank has not yet shifted to a more dovish or even neutral posture. Once it does, there might be ample scope for the franc to move lower.
We shift from negative to neutral on the krone due to the strength in oil prices, better-than-expected economic data, and hopes of further monetary tightening. A jump in core inflation to 7% YoY vs. 6.6% expected increased pressure for further Norges Bank policy tightening and pushed the krone higher.
That said, we are cautious due to the krone’s high beta to equity market risk during this highly uncertain macro environment. In the long term, the story is more positive. The krone is historically cheap relative to our estimates of fair value and is supported by steady long-run potential growth.
We are tactically neutral on the krona. Now that the krona has bounced off oversold levels, we need to see a meaningful increase in expected policy rates and/or signs of economic recovery for a sustained recovery in the krona. We see neither. At the same time, we do not see large downside risks to the currency. The Riksbank is likely to keep pace with or tighten more than the ECB over the next several months and the cheap krona already reflects the ongoing recession risk in Sweden. Once Swedish and global inflation is under control and the economy begins a more durable recovery, the historically cheap krona has substantial room to appreciate back toward its long-run fair value.
We continue to see risks in the Australian dollar tilted to the downside though stronger commodity prices have helped to improve our forecast. Weaker-than-expected inflation, sluggish growth, and the dovish RBA monetary policy pivot are tough for the Australian dollar to overcome in the near term. Rising risks to global growth and equity market performance in H2 and into 2024, in our view, linger as another important risk on the horizon. In the longer term, the Australian dollar outlook is mixed. It is cheap vs. the US dollar, the British pound, the euro, and the Swiss franc, and has room to appreciate, but is expensive against the yen and the Scandinavian currencies.
We are pessimistic on the New Zealand dollar in the near term. Rising recession risk and the weak external balance – the current account is –8.1% of the gross domestic product – more than offset any benefit of high yields, particularly now that the Reserve Bank of New Zealand has likely ended its tightening cycle. We expect the tepid Chinese growth outlook and risks of slower global growth into 2024 to be additional headwinds for the currency. In the longer term, our New Zealand dollar outlook is mixed. Our estimates of long-run fair value suggest that it is cheap vs. the US dollar and the Swiss franc, and has room to appreciate, but is expensive against the yen and the Scandinavian currencies.
Click Download for a more detailed report.
Investing involves risk including the risk of loss of principal. All material has been obtained from sources believed to be reliable.
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 31/07/2023 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.
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.
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: 31/08/2024