Neutral. Trade tensions have resulted in a partial change to our view. We have revised our expectation for a broad US dollar weakening trend, now believing it may appreciate versus currencies linked to China as trade tensions increase. At this point, it appears likely any increase in tariffs may adversely affect valuations of Asian currencies (excluding Japan) such as the Chinese renminbi and Korean won. In addition, volatility generated by tariffs may cause capital flight from these countries, potentially resulting in additional depreciation versus the US dollar. If there is any US dollar depreciation, it is likely to be versus currencies of countries growing above-trend and delivering hawkish central bank surprises.
Overweight. We believe the recent consolidation in the euro is complete, with a new bottom of 1.15 established for the euro/US dollar exchange rate range for the second half of the year.1 Any further disruption across emerging market (EM) currencies would support the euro against EM currencies, while a recovery in risk appetite across EM currencies would support the euro against the US dollar.
Neutral. The renminbi/US dollar exchange rate moved from 6.7 to 6.8 in mid-July as trade tensions and onshore monetary easing measures weighed on the renminbi. Capital controls on outflows remain tight, and financial opening measures (such as the addition of Chinese equities to the MSCI EM Index and upcoming inclusion of Chinese bonds in the Bloomberg Barclays Global Aggregate Bond Index) should increase overseas demand for onshore assets, helping maintain stable inflows. However, trade tensions and domestic monetary easing are likely to continue to pressure the renminbi lower in the near term. We expect 6.9 to be the next test level.
Neutral. The yen traded sideways versus the US dollar in July. It initially tracked US yields and equities higher, reaching the 113 level as risk sentiment around trade concerns began to ease, but fell back to around 111 on increased speculation of a hawkish Bank of Japan (BOJ) at the July meeting.1 The announced BOJ policy adjustments were, however, viewed as dovish by the market. The yen underperformed as the US dollar reversed its recent weakness, rallying back towards 112 as investors covered their short positions.2
British pound sterling
Neutral. Sterling is likely to be driven by developments in the Brexit discussions and expectations for rate hikes. We do not expect to see a breakthrough on Brexit anytime soon. The Bank of England delivered a unanimous 0.25% rate hike to 0.75% in its August meeting (as widely expected), and revised its growth and inflation forecasts upwards.3 Governor Carney, however, signaled that policy tightening would remain gradual and the chance of a no-deal Brexit is “uncomfortably high.” This resulted in the sterling/US dollar exchange weakening towards 1.30.4 Over the medium-term, we expect sterling to continue to appreciate, but we will need to see some positive economic developments from the Brexit negotiations for this to materialize.
Neutral. The Canadian dollar has been trending lower for most of the year. The Bank of Canada (BOC) hiked the overnight rate to 1.75% in July, but this did little to slow the Canadian dollar’s slide.5 Economic data have been generally positive, even with housing growth slowing. Employment gains remain reasonably strong, and retail sales showed a significant bounce in May after the weather-affected April drop. Inflation continues to edge higher with the BOC core measure near 2.0%.6 We believe the currency should be set for a rebound.
Underweight. The Australian dollar has struggled recently on the back of slower Chinese growth and increased tariff escalation between the US and China. Slower Chinese growth has pushed metal commodity prices lower, increasing interest in short Australian dollar positions. Slower housing growth combined with over-extended consumers are also weighing on the currency. With no end in sight for trade disputes, we currently do not see any upside to the Australian dollar.
Negative. The rupee has experienced a significant selloff, depreciating 7.94% year-to-date against the US dollar.7 This was largely driven by an increase in crude oil prices, foreign portfolio outflows and investor fears of a higher current account deficit. Looking ahead, we believe risks to the rupee are tilted to the downside as the balance of payments remains under pressure from portfolio outflows, higher crude prices and higher trade deficits.
1 Source: Bloomberg L.P., July 17, 2018 and July 27, 2018.
2 Source: Bloomberg L.P., July 31, 2018.
3 Source: Bank of England, Aug. 2, 2018.
4 Source: Bloomberg L.P., Aug. 2, 2018.
5 Source: Bank of Canada, July 11, 2018.
6 Source: Statistics Canada, July 20, 2018.
7 Source: Bloomberg L.P., July 24, 2018.
The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries. An investment cannot be made into an index.
The Bloomberg Barclays Global Aggregate Bond Index is an unmanaged index considered representative of the global investment-grade, fixed-rate bond market.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
The Invesco DB US Dollar Bullish (UUP) rose $0.10 (+0.40%) in premarket trading Friday. Year-to-date, UUP has gained 5.29%, versus a 7.25% rise in the benchmark S&P 500 index during the same period.
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