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USD Holds Steady in Tight Range

Equities rose and bonds fell in February as stronger economic growth and stubborn inflation triggered investors to adjust rate cut expectations for 2024. The USD topped the currency performance charts for the second consecutive month. Tactically, we have now turned neutral on the SEK.

From an extremely hawkish backdrop — marked by a positive US dollar and negative equity environment — in October, we transitioned to an extremely dovish landscape in January, with a weakening US dollar and a surge in equity optimism. Since then, we have settled into a more balanced position where monetary easing expectations closely align with central banks’ guidance, strong growth continues to support equities, and the US dollar is in the middle of its nine-month range.

Aside from a small bias for a short-term technical pullback in the US dollar, we likely need to see a much more material shift to break back up to last year’s highs or down to the January lows. However, for now, growth and inflation trends appear stable and central banks remain frozen, waiting for a clear sign that it is safe to ease policy, but they are far from a point where they would tighten policy. This suggests that, unless there is a material surprise in economic data, currency markets and the US dollar are likely to trade in tight ranges for the next month or more.

Figure 2: February 2024 Directional Outlook

Currency Market Commentary March 2024

Within those tight ranges, we expect currencies to oscillate based on relative growth, inflation, and, consequently, monetary policy expectations. Lower inflation and/or dovish central bank comments favor moderate weakness in the Canadian, New Zealand, and Australian dollars, as well as the Swedish krona. The euro and the British pound can enjoy small, limited gains, adding to their January and February outperformance as their economies recovered slightly from near-recessionary conditions last year. But much of the anticipated gains have already been priced in and we do not expect strong economic recoveries in the region.

US Dollar (USD)

We have long held the view that the US dollar is likely to fall at least 10–15% over the coming years, but is currently in a noisy transition period from a bull to a bear market in a protracted range-trading environment. We strongly recommend investors with a horizon of two years or more to position for a lower US dollar.

However, a sustained US dollar bear market does not appear imminent. For those with a shorter, tactical horizon, we believe the dollar will remain well supported in a range-trading environment, at least over the next few months. The G10-leading US growth and interest rates provide strong near-term support, which is further underpinned by the tendency of the dollar to rise in times of stress, serving as a nice insurance policy should an unforeseen shock derail the current soft or no-landing scenario. There is room for a modest upside over the coming months.

That said, the US dollar is optimistically priced following the January–February rally and vulnerable to a temporary sell-off over the next 4–6 weeks on even minor signs of weaker growth or inflation.

Canadian Dollar (CAD)

The Canadian dollar remains one of the lowest-ranked currencies by our short- and medium-term models. The rapid deceleration in growth, alongside weak and choppy commodity prices, suggests further dollar weakness. Resilient inflation and labor markets support the currency via tight monetary policy, but that is changing. Lower-than-expected January inflation and signs of softness in the employment report suggest that economic slack is leading to renewed disinflation, opening the door to a more dovish Bank of Canada. This risk appears to be underappreciated in current market pricing and suggests scope for near-term Canadian dollar weakness.

In the long term, looking through the weaker cyclical picture, the Canadian dollar looks more attractive as it is cheap in our estimates of fair value relative to the euro, the Swiss franc, and the US dollar. Additionally, its long-term potential growth is poised to improve on an aggressive increase in immigration and substantial plans to invest in sectors such as green energy technology.

Euro (EUR)

We maintain a neutral view on the euro against the G10 average and a negative view on the US dollar and the yen. This is not a good environment for the euro as the combination of ongoing stagnant growth in the European Union (EU) and expectations of European Central Bank (ECB) easing is likely to weigh on the currency. Offsetting that negative force is the slowing pace of disinflation and a robust labor market, which may keep the ECB on the sidelines until summer. It also appears that investors may be overly pessimistic on EU growth prospects. Economic data shows ongoing stagnation but has been coming in above pessimistic market expectations, which is favorable for the ongoing euro stability.

British Pound (GBP)

Our factor models remain neutral to slightly negative on the pound versus the G10 average, but negative on the yen and the US dollar. As the economy stagnates, disinflation continues, and the constraining effects of the high fiscal and current account deficits loom, we see downward risks for the pound.

However, in the very short term, those downside risks are partly offset by a few factors. Firstly, we see similar risks across most G10 economies and currencies, leaving the relative tactical pound outlook only slightly negative versus the G10 average.

Secondly, it appears that Q4 2023 marked at least a temporary low in growth, with data picking up in January–February 2024. Finally, with growth stabilizing, core inflation over 5%, and wage inflation over 6%, the Bank of England faces greater constraints on easing policy, providing the pound with some yield support.

Our long-run valuation model has a more positive pound outlook as the currency screens as cheap to fair value. But we expect sticky inflation and chronically weak potential growth post-Brexit to likely weigh on fair value, somewhat limiting that potential pound upside over the next several years.

Japanese Yen (JPY)

Our models have maintained a positive view on the yen relative to the G10 but retain a negative view versus the US dollar, given high US interest rates and strong relative growth. Much better-than-expected performance of the US economy and the resultant delay of the first rate cut are likely to keep the yen on the weak side longer than previously expected. But we see risks skewed toward a broad yen recovery in 2024 as yields peak and turn lower, while below-trend global growth (maybe only returning to trend in the US) later this year should increase the chance for periods of volatility in risky assets.

The increased likelihood that the Bank of Japan (BoJ) exits its negative interest rate policy by April is also supportive, though the magnitude of potential BoJ rate increases is tiny compared to the scope for rate cuts across the rest of the G10.

Swiss Franc (CHF)

We are negative on the franc over the strategic horizon, but have a rare neutral signal over the tactical horizon relative to the G10 average — still tactically negative vs. the US dollar and the yen.

This neutral signal against the G10 basket is almost entirely the result of our short-term value signal, which suggests that the recent depreciation may be a little ahead of itself and due a minor pullback. Beyond that, the franc remains the most expensive G10 currency per our estimates of long-run fair value, has the second lowest yields in the G10, and inflation is falling faster than expected.

With the real trade-weighted franc near 30-year highs, any further strength could easily induce the Swiss National Bank to intervene to weaken the franc. Such a shift is likely to provide a catalyst for the highly overvalued franc to begin a reversion back down toward our estimate of its long-term fair value.

Norwegian Krone (NOK)

Our short- and medium-term models remain negative on the krone due to choppy oil prices, disappointing growth data, and signals from our short-term value model suggesting that the krone’s strength over recent months is ahead of its fundamentals.

Even the relative tightening of the Norges Bank monetary policy outlook has had limited impact beyond the near term. The Norges Bank may hold off on rate cuts longer than other central banks, but tepid growth data and an ongoing disinflation suggest a steady policy easing later this year and into 2025.

Going forward, we also think it prudent to be cautious on global risk sentiment and its impact on the krone as it is highly sensitive to equity and commodity market downside should the goldilocks narrative sour. In the long term, the outlook is positive. The krone is historically cheap relative to our estimates of fair value and is supported by steady potential growth.

Swedish Krona (SEK)

Our models are neutral on the krona over the near term. Growth has been chronically weak but is showing some signs of improvement, especially versus depressed expectations, very much like the broader EU. This stabilization in the context of the historically cheap krona valuation suggests recovery.

However, any resulting krona bullishness is offset by persistently negative growth and the dovish Riksbank. They have been willing to look through the upside surprise in headline Consumer Price Index given a more stable core at 4.4% YoY. In fact, the six-month annualized core cost-plus-incentive fee is 0.0% compared to 7.2% for the six months that ended in January 2023.

It is believable that the Riksbank may cut sooner and faster than the ECB, which would be very welcome news to the heavily indebted household and property sectors, though not great for the currency over the short run.

Australian Dollar (AUD)

We continue to see medium-term risks tilted to the downside for the Australian dollar on tepid commodity prices, underperformance of Australian equity markets, and the recent downside inflation surprises.

While we have seen some improvement in consensus growth expectations one year ahead, the more recent growth data has been disappointing. However, it is important to note that the Australian dollar is cheap relative to history, suggesting many of these negative factors are priced into the currency. We also expect stabilization (but not recovery) in Chinese growth following the recent fiscal and monetary stimulus. However, investors are currently reacting poorly to announcements of Chinese stimulus and likely need to see the positive impacts before they spill over to support the dollar.

In the long term, we are decidedly more positive on the Australian dollar versus the US dollar given the extreme undervaluation and Australia’s higher-than-average long-run potential growth.

New Zealand Dollar (NZD)

We are negative on the New Zealand dollar over the near term. Ongoing challenges to growth, choppy commodity prices, and the weak external balance — the current account is –7.6% of GDP — more than offset any benefit of high yields even after the upside Q4 inflation surprise reported in January.

However, all is not bad. The markets may have been disappointed by the Reserve Bank of New Zealand in February, but markets still expect New Zealand to begin its easing 1–3 months later than most G10 central banks and cut less; this seems a reasonable expectation. As a result, the New Zealand dollar is likely to remain among the highest-yielding G10 currencies through 2024.

In the longer term, our New Zealand dollar outlook is mixed. Our estimates of long-run fair value suggest that it is cheap versus the US dollar and the Swiss franc and has ample room to appreciate, but is expensive against the yen and the Scandinavian currencies.

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