The USD entered 2020 on a firmer footing after ending 2019 in the doldrums. Rising US-Iran tensions partially reversed the erosion of USD’s safe haven status fuelled by the earlier melt-up in risky assets from easing trade concerns, stabilising global activity data and China's reserve requirement ratio (RRR) reduction. Other haven currencies/assets such as the JPY and gold have also rallied in the New Year.
The extent of the boost for the USD will depend on the scope for a large and persistent oil price rise that could hurt a global economy that is only just starting to stabilise. Recent history would suggest that oil price spikes from geopolitical tensions, such as the September attack on Saudi Arabia's Abqaiq crude processing facility, is likely to fade, although the weak global growth then had also helped contain the move higher in oil prices.
Worries over higher oil prices derive from the view that Iranian authorities collectively, or the Islamic Revolutionary Guard Corps independently, could potentially take retaliatory actions that increase the likelihood of oil supply disruption in the Middle East. While the risk of an oil spike persists, a move into the USD70s seems manageable for the global growth outlook. The calm in long-dated oil futures, arguably, reflects investors’ confidence that the world has ample spare capacity at the moment to contain the threat of persistently higher oil prices.
While we expect the USD to end 2020 moderately weaker, the December USD sell-off especially against risk-sensitive G10 and EM currencies seems overdone. We think the USD is more likely to move sideways at least for the early part of 2020.
Investors should take advantage of the still-low volatility to position for a tactical USD rebound via options. First, renewed geopolitical risks could support the USD versus the risk-sensitive currencies. Amongst the risk-sensitive currencies, oil exporters (CAD, RUB) should fare better than oil importers (ZAR, INR, AUD, NZD). Second, the USD’s G10 high-yielder status as “too expensive to sell” is set to linger and limit opportunity to sell the currency. Third, we do not expect any further Fed rate cuts in 2020, which also limits the case for aggressive USD weakness. Fed officials appear to have settled on a consensus that monetary policy is “in a good place,” and the bar for a change in either direction over this year appears high.
Enthusiasm for the bearish USD trade would require the EUR and CNY to appreciate meaningfully - and we do not see a compelling case for either at this point.
The Phase 1 trade deal, which is slated to be signed on 15 January, is CNY positive from a near-term sentiment perspective but still leaves open long-term escalation risks. It is not likely to be a game changer for the CNY, with the outlook favouring broad stability. President Trump has announced that he will visit Beijing later to begin the Phase 2 talks (although not confirmed by China). However, we do not expect significant progress, if any, to be made in Phase 2, given it is likely to be focused on challenging structural issues. CNY will likely struggle to sustain its appreciation. There is also little policy appetite for CNY strength with China’s economic growth still lacklustre. There is likely more monetary easing on the cards for China but do not expect big stimuli given the need to curb financial risks.
The EUR may also find it hard to shed its funding currency status for the time being. EUR (and CHF) are still valid funding currencies but investors should be patient with entry levels, as 2020 will overall be a year of moderate USD weakness. The EURUSD could eventually be headed up, and the next big move in the EUR will probably be higher. But the timing could be tricky, and we could remain stuck in an extended consolidation phase, with the EUR caught between opposing forces.
The outcome of the November US presidential election could bring fresh uncertainties for the USD. However, it is probably too early for the market to properly discount the outcome amid questions over the Senate impeachment trials. It is probably also premature to prejudge the Democratic nomination outcome when primaries do not begin for another month (Iowa Caucus 3 February, Super Tuesday 3 March).Disclaimer applicable to recommendation
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