The high-growth, high-yield, safe-haven USD was the big winner in August, while the risk-sensitive NOK led the downside despite stronger oil prices. Tactically, we shift from neutral to slightly positive on the NOK as it appears oversold relative to the recent strength in oil prices.
Despite our longer-term bear market thesis, it is hard to argue against the US dollar at the moment. It is both a defensive and high-yielding currency, while the US economy is holding up better than most – a very attractive trio of factors for the dollar against the backdrop of a fragile world. This is especially true, heading into September, which typically brings higher level of equity market volatility.
In the near term, currency market performance is likely to look similar to that in August, with more cyclically sensitive currencies underperforming. There are a couple of exceptions relative to August. The British pound looks increasingly vulnerable as economic data surprises turn negative, and, while we expect the Norwegian krone to have difficulty in the face of higher equity volatility, it looks increasingly oversold relative to strong oil prices.
August 2023 Directional Outlook
We confidently believe that the next big, sustained move in the dollar is lower – a broad decline of 10%–15% – but it appears early for that now. The near-term US dollar outlook is improving. It is hard to argue against a defensive currency with high yields and strong growth in a world fraught with macro fragilities. We expect relative US growth and yields to converge lower with the rest of the world over the course of 2024 and that process may begin over the next few months.
Eventually, 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 coordinated global recovery, catalyzing a sustainable and large US dollar downtrend.
Our models are neutral on the Canadian dollar, with improved oil prices offsetting modest softening in economic data and sluggish relative Canadian equity market performance. Like the US, the Canadian labor market is tight, and the consumer is holding up better than one might expect, given the high levels of household debt and the rapid rise in interest rates over the past year, though we see early signs of softening domestic demand. Its high correlation to US dollar also makes it more attractive than other more cyclical currencies such as the Norwegian krone and the Australian dollar in a global hard landing scenario, though the Canadian dollar may likely underperform the US dollar in that scenario.
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 maintain our neutral to slightly negative view on the euro in response to the steady stream of weaker economic data surprises and rising stagflation risk. Any return of pessimism and equity volatility over the next few months would likely support the euro vs. higher-beta currencies as we saw in August, but a broad euro upside appears unlikely in the near future.
European Central Bank (ECB) policy rates are middling relative to the rest of G10, providing only limited yield support for the euro, while the risk of recession is rising as the ECB tightens monetary policy, creating greater headwinds for an EU economy that is already flatlining.
Our view of the British pound is increasingly negative in response to the decelerating economic data, persistently high inflation, and poor UK equity market performance. We expect the Bank of England (BoE) to raise rates again at its September meeting and probably at least one more time by year-end . But that may provide little support for the pound as tighter monetary policy further damages an economy already teetering close to recession.
Our long-run valuation model suggests that the pound is cheap. However, low productivity growth and high inflation are pushing fair value lower, which is on pace to trend down to the lower 1.30s against the US dollar over the next few years. The pound is still cheap at those levels, but UK’s cyclical weakness and falling long-run pound fair value make for a tough outlook for the BoE and the currency into 2024.
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 next year. This supports yen strength via improved yield differentials and safe-haven demand. The 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, particularly as any further material weakness incentivizes another round of government intervention to support the yen.
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.
We expect another policy rate increase from the Swiss National Bank (SNB) in September, but think that will be accompanied by more neutral comments and a reduction in the SNB’s propensity to intervene in support of the franc. Such a dovish shift should encourage the highly overvalued franc to correct lower, though the rising risk of EU stagflation and the fragile global macro may delay the expected sell-off.
We shift from neutral to slightly positive on the krone as it appears oversold relative to the recent strength in oil prices, late August recovery in equity markets, and hopes of further monetary tightening.
Our current small positive bias is only over the near term. We continue to see medium-term risks due to the recent slowdown in growth data and 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 in our estimates of fair value and is supported by steady potential growth.
In August, we shifted from neutral to modestly negative on the krona on a weaker economic outlook and poor local equity market performance. The Riksbank is likely to keep pace with or tighten more than the ECB over the next several months given the stickiness of core inflation. That sounds positive on the surface, but will put further pressure on the economy and weigh on the krona’s outlook.
Eventually, likely in 2024, Swedish and global inflation will be under control and the economy will begin a more durable recovery. Once that happens, the historically cheap krona has substantial room to appreciate back toward its long-run fair value on a sustained basis.
We see risks in the Australian dollar tilted to the downside as we see rising risks to global growth and equity market performance later this year and into 2024. China is unlikely to provide meaningful support for global growth, and Australia.
That said, there are some positive signs – such as stronger homes prices, low unemployment, strong wage growth, rising energy prices, and an increased pace of Chinese stimulus – that suggest the strong Australian dollar downtrend over the past couple of months may slow for a time, or even reverse slightly. 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 over the near term. Rising recession risk and the weak external balance – the current account is –8.1% of gross domestic product (GDP) – 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 expensive against the yen and the Scandinavian currencies.
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