Predicting this year’s winning currency is more like judging an ugliness contest. Hard for USD to repeat 2018’s out-performance, as concerns of US joining the global slowdown and a more dovish Fed have undermined the USD. FX is a battle between a host of unloved currencies to see which is worst. Despite stronger dislike for the USD, it is not clear (for now) that the USD is the worst of the bad bunch.
It is difficult to ignore the damage being done to business confidence and the potential risks to supply chains and US growth from escalation of US-China trade tension. Various Fed officials have joined Chair Powell in underlining the case to “pause” the rate hike cycle for the time being as the Fed assesses financial and economic developments. Another move in 1Q looks unlikely.
While the Fed is on course to acknowledge the weaker growth environment, it is also far from obvious from activity data that the US economy is going to experience anything but modest slowing of its otherwise robust pace of growth. The case for a US recession is more evident in financial markets than in the economic data. In the end, the Fed will need to push rates up to neutral (or higher) which points to another two or three hikes.
With the market now priced for no rate hikes at all in 2019, it would appear to have over-reacted to the recent news flow. Therefore, excitement about a potential turn in the Fed rate cycle fueling sizeable USD downside seems premature at this point.
Still, if we are heading into a period of side-ways trading in US interest rates, it seems likely that high-yielding EM FX (such as IDR, BRL and RUB) can continue to stay firm against the USD, provided that we can avoid big downside re-pricing of global growth expectations.
USD is the high-yielding currency play in G10. It is still a struggle to find compelling reasons to own other G10 currencies such as EUR, GBP or AUD and forgo USD’s high yield. The weak Euro area and China data is a reminder that growth outside of the US remains anemic while political risks remain a hurdle especially on Brexit even though news from Italy and US-China trade tension has been somewhat positive.
Despite stronger dislike for the USD, it is painful to forgo USD’s high yield
Source: Bloomberg, Bank of Singapore
On the flipside, the USD appears over-owned. In terms of positioning, the market is actually long rather than short USD according to currency futures (CFTC) data. If the growing consensus for a weaker USD in 2019, which we are part of, proves to be right directionally, history suggests that the realised FX move could be larger than expected.
We expect the balance to tip towards a much weaker USD by mid-2019, as growth outside the US improves. At present that remains more forecast than fact, so we will be watching incoming data from China and the Euro area particularly closely. A rebound to Fed rate hike expectations is unlikely to stand in the way of weaker USD to the extent that this is led by improving global growth (as oppose to mainly US growth) outlook.
Policy-makers in China are focused on growth and will calibrate their response as necessary, so we expect further monetary and fiscal easing to stabilise China’s economy over the next few months. Meanwhile, China could use a respite from the negative spiral that the bilateral relationship with the US seems to be in.
Disclaimer applicable to recommendation
JPY could give back some of its recent strength as the global risk backdrop stabilises after the financial market rout in late December and early January. However, we continue to look for opportunities to re-build long JPY exposure as a portfolio diversifier during late-cycle investing.
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