Rising yields and weaker equity markets due to concerns about slowing global growth dominated the currency market in April. Perceived growth risks emerged because of the real income impact of high inflation, tighter monetary policy, further spillover impacts from the Russia-Ukraine War, and the ongoing COVID-19 lockdowns in China. Commodity prices, a key currency driver in recent months, moved sideways with a reduced impact on the currency market. However, this environment was ideal for the USD, which trended steadily higher against the entire G-10 universe.
Figure 1: April Currency Return vs. G-10 Average
It is difficult to see a near-term resolution to the hard landing as central banks tighten policy, COVID-19 lockdowns continue in China, and uncertainty about the Russia-Ukraine War lingers. We will expect global risk sentiment to remain stressed and the USD to remain well supported and possibly move a bit higher despite its historically expensive level. Until April, commodity currencies benefitted more from rising commodity prices than they were hurt by choppy equity markets and concerns over China’s growth.
With commodity markets in a volatile range, albeit with clear risks of another surge, the challenged global equity/risk sentiment impact should become more prominent and keep commodity currencies under some pressure in May. We expect that we are nearing a local peak in central bank expectations but may see some potential for longer-dated yields to move higher; they certainly have momentum on their side. In that case, the lower yielders, the EUR, the CHF, the JPY, and the SEK, should also remain under pressure.
Figure 2: April 2022 Directional Outlook
The USD soared in April, up 4.7% versus the G-10 average. The story is simple: the United States (US) is very attractive as a refuge in this period of heightened uncertainty. It enjoys high/rising yields, weaker equity markets, and strong underlying economic conditions that are resilient to Russia-Ukraine War risks, high commodity prices, and the slowdown in China. These themes were highlighted during the month, with the unemployment rate falling to 3.6% and the US Fed indicating quantitative tightening as early as May and moving to raise policy rates by 50 bp instead of 25 bp. James Bullard from the Federal Open Market Committee (FOMC) also floated the idea of a 75 bp rate hike, something the market was more than willing to partially price into expectations for the upcoming May meeting.
The USD is highly overvalued from a long-run perspective. Relative to the currency basket in the MSCI World ex-USA Index, its valuation is now only 2% from its high in Q1 2002 — marking the end of a seven-year bull market giving way to a near 40% downtrend in the USD over the following nine years. At these valuation levels, the USD is clearly at risk over the longer term. But it is difficult to see it falling back while US rates continue to rise rapidly and uncertainty from the Russia-Ukraine War and disruptions in the supply chain due to COVID-19 remain elevated. Until the macro environment stabilizes, the USD is likely to continue to find support. That said, our 3–5 year USD outlook remains firmly negative. We believe that we are in the process of forming a top to the eleven-year USD bull market. At some point, inflation will roll over, US monetary policy expectations will peak, and many of the stresses holding back the economic outlook outside the US will abate. In this context, cheaper non-US assets will look much more attractive, incentivizing outbound capital flows and a weaker USD.
The euro fell 0.6% relative to the G-10 average – a loss of 5.3% versus the USD. Growth risks from high energy costs, dampened sentiment from the Russia-Ukraine War, and the sharp rise in yields in the US are some of the factors that pushed the currency lower. The month started on a sour note with talks of restrictions on Russian energy imports by the European Union (EU). The restrictions were not imposed, but the issue came back to drive the EUR lower on 27 April as Russia cut off gas supply to Poland and Bulgaria. However, it could have been worse for the currency. Hawkish comments from several European Central Bank (ECB) policymakers contemplating a rate hike as early as July helped Germany’s 10-year yields to trend up from 0.55% to 0.94% and the EUR sustained a strong mid-month rally, particularly against the lower-yielding JPY and CHF. The EUR also tends to be moderately less sensitive to negative equity market performance than other G-10 currencies given its persistent current account surplus. Thus, the EUR also outperformed the equity sensitive currencies — the NOK, the NZD and the AUD.
We are broadly negative on the EUR due to growth and inflation risks from the Russia-Ukraine War, which may soften the monetary policy’s response to high inflation and disincentivize capital flows into the region. Even if the ECB shifts to a hawkish-inflation fighting stance despite heightened growth risks, it is unlikely to provide significant support to the currency. Foreign exchange markets tend to penalize currencies when central banks are forced to tighten into a stagflationary environment, something that has been very apparent for the British pound. Longer term, once the uncertainty over the Russia-Ukraine War subsides (which could take very long in the worst-case scenario), we see room to have a more constructive discussion on the EUR. The current conflict is a clear negative for now, but over the medium term it incentivizes greater EU integration, higher fiscal spending, and a more rapid transformation toward alternative energy sources. All these factors could ultimately promote a higher, long-run potential growth rate and support a sustained post-crisis recovery in the EUR.
The pound was near flat in April, gaining 0.1% relative to the G-10 average, thanks to a strong rally in the first half of the month. The bulk of that early month rally happened after US core inflation came in below estimates on the 12th and UK core consumer price index (CPI) for March surprised to the upside at 5.7% YoY versus expectations of 5.3%. Employment data showed weaker-than-expected job growth but was well-received by markets as the unemployment rate ticked down to 3.8%. The pound’s gains were short lived. The second half of the month brought a sharp downturn in retail sales, softening on the manufacturing purchasing managers index (PMI), and weaker consumer confidence. This recasts the positive inflation surprise as a stagflationary risk complicating the Bank of England’s (BOE) policy outlook and weighing on the GBP. The acceleration of losses in equity markets also likely helped drive the currency lower to ultimately erase its earlier month gains.
Our view on the GBP is mixed. Near term, we are neutral. Economic risks from a potential slowing of the UK’s growth, fiscal drag, and eroding consumer purchasing power from elevated inflation are negative for the GBP. The BOE is increasing rates but is not expected to reach the levels of tightening expected in the US, Norway, Canada, Australia, or New Zealand. However, our short-term models suggest that the GBP is oversold despite these challenges and it is difficult to chase the GBP lower from here. Longer term, we are more constructive. Once geopolitical uncertainties resolve, we see greater room for the currency’s sustained appreciation powered by its cheap valuation versus its long-run fair value, eventual recovery in fundamentals, rising policy rates, and our expectation for broad long-run USD weakness. The obvious complication being that timing the start of a longer-term recovery is difficult. For the foreseeable future, risks from a more significant global slowdown and intensifying stagflation risks in the UK may delay any long-run recovery in the GBP, even as late as H2 2023 or beyond.
After losing 5.3% relative to the G-10 average in March, the yen’s downtrend continued — another 3.7% during the first few weeks. A bounce back amid accelerating equity market losses and a temporary pull back in the US yields helped the JPY to bounce back almost 3% until it once again turned lower toward the month-end to finish down 1.7%. Despite the ongoing currency weakness, the Bank of Japan (BOJ) held steady to its yield curve control policy and shrugged off any negative impacts of the weaker JPY via its role in exacerbating the rise in import prices. At its meeting on the 28th, the BOJ reiterated this position and pledged to continue with its open-ended purchases of 10-year Japanese Government Bonds. While the JPY’s losses versus the USD rivaled those in March, choppy commodity prices and a negative turn in equity risk sentiment helped the JPY to appreciate versus risk-sensitive commodity currencies such as the NOK and the NZD.
Our short-term models suggest more losses in the future. Japan’s growth and core inflation are among the weakest in the G-10, incentivizing the BOJ to stick by its ultra-loose monetary policy. The potential for rising global risks from the Russia-Ukraine War and recessionary risks from the rapid tightening of global monetary policy may slow the pace of JPY’s depreciation, but that is unlikely to be significant enough to prevent losses outright, particularly against the USD. Long-term, the JPY looks very cheap and is near its 30-year low on a real effective exchange rate basis. The weakness in the currency appears to be a rational response to underlying cyclical fundamentals. Once the cycle turns — global inflation and growth roll over in coming quarters, bringing down expectations of monetary tightening — the JPY has ample room to appreciate back toward its fair value.
The CHF lost 0.6% versus the G-10 average in April. The currency largely moved sideways during the first two weeks despite negative pressure from rising global yields and a notable pick-up in sight deposits suggesting greater intervention from the Swiss National Bank (SNB) to limit CHF gains. Support came from increased risks to the EU’s growth from the potential for disruptions to Russian energy supplies. The currency dipped mid-month as the EUR rallied in response to the ECB’s indication of a possible rate hike in July until it found support late in April on the pullback in US yields and accelerated equity market sell.
Near term, we are neutral on the CHF as its economy is less sensitive to spillover risks from the Russia-Ukraine War and it tends to do well during periods of high uncertainty and volatile equity markets. Longer term, we are negative on the CHF due to its ultra-low yields, low inflation, prospects for accelerated intervention from the SNB to limit further CHF gains, and extreme overvaluation versus the long-run fair value. We see merit in the argument that the SNB should begin to tighten monetary policy at some point, which may be marginally positive for the currency, but we also believe that the degree and timing of such tightening will likely lag the rest of the G-10, including the ECB.
The CAD gained 2.4% versus the G-10. The month started on a quiet note. New job creation in March was strong but slightly below expectations, though the unemployment rate ticked down to 5.3% — near its 50-year low. Strong growth, employment, and inflation prompted the Bank of Canada (BOC) to raise its policy rate by 0.5% at its meeting on the 13th . Additional 0.5% increases are expected this year given the hawkish tone of the central bank and further upside surprises in inflation, +6.7% YoY for March versus 6.1% expected. The CAD trended steadily higher following inflation and the announcements made by the BOC to finish as the second-strongest currency in the G-10. It is also important to note the strong linkages between the USD and the CAD given the deep economic and capital market linkages between the two countries. The CAD tends to outperform the broad G-10 when the USD is strong as it was in April.
Our view on the CAD remains positive due to rising yields, high commodity prices, and a strong domestic economy. The strength and breadth of our signals across equity markets, commodities, economic growth, and interest rates provide a confident basis for additional CAD appreciation. However, that expected appreciation may come with higher volatility. We expect volatility to remain elevated given heightened commodity market volatility and growing uncertainty due to rapid monetary tightening. Also, after posting the best performance in G-10 last year and the second-best performance in G-10 year to date for 2022, a fair amount of the good news is already priced into the CAD. Thus, longer term, our outlook is mixed. The CAD is cheap and has the potential for sustained long-run appreciation versus the USD and the CHF. However, it is expensive versus the GBP, the JPY, and the Scandinavian currencies, and may also underperform.
The krone lost 1.4% versus the G-10 average and 6.1% against the USD. Until 20 April, the NOK performed well, up nearly 1% despite a disappointing March CPI release on the 11th, 4.5% YoY relative to 5.0% expected. The currency was well supported by oil prices holding above US$100/barrel with upside risk including the EU’s restrictions on imports of Russian oil and the positive impact of the Norges Bank’s upward revision to its expected policy at its March meeting. However, with oil prices failing to rally further and equity sentiment turning sharply negative later in the month, the NOK gave way and tumbled almost 3.5% between 19 April and 27 April to finish as the third-worst performer in the G-10.
We are positive on the currency over both short- and long-term horizons based on its strong fundamentals, but we tend toward neutral over the short term due to its sensitivity to higher equity market volatility. The NOK is historically cheap on a real effective basis and against our estimates of its long-run fair value. Additionally, cyclical fundamentals also support NOK appreciation. The potential for a resurgent Russia-Ukraine War as well as longer-term underlying supply/demand dynamics suggests continued oil market strength, which will only bolster Norway’s record trade surplus. Though the benefits of high oil profits will likely be partly diluted by the Norges Bank’s daily sales of NOK. In short, the krone is a cheap currency with commodity support, rising yields, and solid growth fundamentals. We expect strong gains over time but reiterate the near-term risks as we grapple with rising global risk aversion and downgraded global growth expectations.
The krona lost 0.2% against the G-10 average and was the third-best performer. Like the EUR, the SEK traded lower for most of the month due to ongoing concerns related to the Russia-Ukraine War and its potential impact on regional growth. Speculations on possible restrictions on Russian energy exports were not helpful. Notable weakness in February’s GDP print, -0.8% MoM versus +0.5% expected, also disappointed markets and indicated a poor starting point to weather the extra stress from the War. On a more positive note, March composite PMI remained above 60.0; anything above 50.0 denotes growth, and retail sales returned to growth at +0.2% compared to the -0.1% in February. The biggest news and reason why the SEK fared well versus the G-10 was the large spike higher in core cost-plus-incentive fee inflation to 1% MoM in March, which prompted the Riksbank to raise rates to 0.25% — the first time the policy rate went above zero since 2014.
The SEK remains weak amongst the cheapest G-10 currencies and is likely to remain weak near term. The shift in Riksbank’s policy is welcome, but divergence between its policy and those of other central banks remains large. The ongoing uncertainty regarding the EU’s growth outlook and the Russia-Ukraine War is also likely to be a drag. We see room for a recovery once we gain even a modest amount of clarity on the War and the gap between Swedish monetary policy and that of the US and other G-10 countries begins to contract. For now, it is best to express a positive view versus other low yielders such as the EUR and the CHF that are also exposed to the EU’s growth and the Russia-Ukraine War.
The Australian dollar fell 0.7% relative to the G-10 average and over 5% versus the USD. For most of the month, the AUD was in the green. The positive move began early after the Reserve Bank of Australia (RBA) dropped the reference to the word patient in its policy statement on 5 April. The AUD initially surged to more than 1.5% gains versus the G-10 before moderating into a +0.5-1.0% range as sluggish equity markets and moderating domestic economic conditions offset some of the RBA’s optimism. Westpac’s consumer sentiment index was slightly lower than expected, as were March employment gains. But, in absolute terms the domestic economy and labor markets remain strong. The acceleration lower in equity markets after 20 April alongside choppy commodity prices overwhelmed the positive tone and sent the AUD into negative territory for the month until a positive surprise in Q1 CPI, 2.1% QoQ versus 1.7% expected on the 16th provided some stability into the month-end.
We remain broadly positive on the AUD due to elevated commodity prices, prospects for RBA rate hikes, and the strong domestic economic outlook. However, over the very near term, we tilt more toward neutral due to the deterioration in global risk sentiment and higher equity market volatility. China’s pledge to increase economic stimulus will likely limit the medium-term negative impact of lockdowns, but for now, the negative impact of lockdowns on China’s growth is likely to dominate and will prove to be a further headwind for the AUD. Thus, the balance of risks points to near-term challenges for the AUD before it can resume its rally.
The New Zealand dollar was the worst-performing G-10 currency, down 2.0%. The NZD, along with the AUD, enjoyed a sympathetic bounce higher after the hawkish shift from the RBA on 5 April. The move reversed quickly, sending the NZD steadily lower for the remainder of the month. The NZD faced the same downward pressures as the AUD: the stalled commodity rally, weaker-than-expected Chinese growth, and lower equity markets. But unlike Australia, where monetary policy tightening is yet to begin, New Zealand is closer to the end of its policy tightening cycle and the country’s growth is moderating to a greater extent than that of Australia. The later cycle status of New Zealand’s monetary policy was highlighted by the Reserve Bank of New Zealand (RBNZ) at its meeting on 13 April. The committee raised rates by 0.5% compared to the 0.25% that was expected, sending the NZD initially higher intraday before reversing lower as investors reacted to RBNZ’s statement. The RBNZ indicated that the surprise 50 bp hike was intended to front-load policy change and provide greater flexibility going forward. Investors read that as a signal that the RBNZ may slow or stop policy tightening sooner than expected.
Our tactical models turned negative on the NZD in March and remained in the negative territory due to deceleration in economic activity, weak domestic equity markets, and deteriorating global risk sentiment. Yields remained relatively attractive; but, as mentioned above, the RBNZ is further along in their tightening cycle while other central banks are becoming more aggressive. Longer term, our view on the NZD is more neutral. Relative to long-run valuations, the NZD appears attractive against the USD and the CHF but is not as cheap as the other commodity currencies. This is likely to restrain any upside in the NZD against the broad G-10, even over the long term.
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