We expect the US dollar to remain well supported — it is hard to beat a high-yielding, safe-haven currency with decent growth. This is particularly true given the rising political risk in France, Mexico and US as the autumn election draws closer.
However, weaker US inflation data and decelerating growth suggest that US dollar upside should be limited; there is a rising risk of a temporary pullback over the summer. In other words, the dollar should be somewhat rangebound albeit at an historically expensive level.
The euro is enjoyed a modest relief rally following the first round of French election, but it was short-lived. The outcome point towards a hung parliament, and there will likely be a prolonged period of policy uncertainty. This extended euro uncertainty will also likely continue to weigh on regional currencies as they are sensitive to EU growth — namely the Scandinavian currencies, and to a lesser extent, the British pound — while supporting the Swiss franc.
Rising political risk and recent weakness in commodity prices — the Bloomberg Commodity Index finished June, 6.1% off its May high — are likely to cap gains in commodity currencies. Within the commodity group, the more hawkish central banks in Norway and Australia should help limit any losses, provided global risk sentiment and equity markets remain strong. On the more vulnerable side is the Canadian dollar, which is vulnerable not only to weaker commodity prices, but also to monetary easing and slow growth.
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 as US yields and growth fall back toward the G10 average, and the US grapples with high fiscal and current account deficits. For investors with a horizon of two years or more, we strongly recommend short US dollar positions; just look through this highly uncertain transition period.
For those with a shorter horizon, we believe the US dollar will continue to be well supported in its range, though there is a rising risk of a temporary summer pullback on weaker employment and inflation data. Aside from any temporary correction, over the multi-month horizon, the dollar remains the top-ranked currency in our models due to high interest rates, the fragile global environment (as defined by our macro regime model), and strong US equity market performance. Heightened political risk in France, Mexico, and the US should also provide support, at least through November. President Biden’s poor debate performance may bring an earlier-than-usual political risk premium to the dollar, given candidate Trump’s stagflationary tariff and immigration proposals.
Canadian Dollar (CAD)
Our models shifted to a negative tactical view on the Canadian dollar in June due to weakness in commodity prices, softer equity performance relative to other currencies, and lower yields. Economic data, while slightly better than expected overall, reveals that the Canadian economy remains well below potential growth, with labor market slack and little sign of recovery. We saw a similar deterioration in forecasts for other commodity-sensitive currencies, with Canada showing the weakest performance; in contrast, Australia and Norway were supported by a combination of better economic growth and expectations for tighter monetary policy for an extended period.
In the long term, however, the Canadian dollar looks more stably attractive against a number of currencies. It is cheap in our estimates of fair value relative to the euro, the Swiss franc, and the US dollar.
Euro (EUR)
We maintain a neutral view on the euro against the G10 average. On the positive side, we have seen better economic data and a significant improvement in year-ahead growth forecasts for the EU, as well as expectations of a more gradual ECB easing cycle. However, any benefit from those factors is more than offset by French political risk.
We saw a modest recovery after the first round of elections, but it was short-lived. There remained a possibility for the RN party to secure an absolute majority, which could have potentially led to increased fiscal deficits and clashes with EU officials.
Even in our base case of a hung parliament, there will be a tendency toward greater fiscal spending, heightened uncertainty as the parties wrangle for power, and decreased cooperation with the broader EU agenda. Most importantly, these issues will almost certainly extend for months or longer, weighing on the single currency.
British Pound (GBP)
Our models have shifted to a positive tactical view on the pound relative to the G10 average, though most of the relative improvement is versus commodity-sensitive currencies. Our view is also bolstered by better UK economic data. We view the UK election as a marginal positive for the pound. Labour Party was sure to win, and their platform is much friendlier for the pound than RN is for the euro.
It is fiscally conservative with reasonable attempts to bolster long-term growth and the potential for greater trade cooperation with the EU — something which is sorely needed to offset the negative impacts of Brexit. Nevertheless, we continue to see underperformance versus the US dollar. The US has higher yields, has better growth, and serves as a safe haven hedge in case of greater political risk or a sharp deceleration in global growth.
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)
The recent strength in US inflation and growth make the timing of Fed rate cuts and sustained yen appreciation highly uncertain. As long as US growth and inflation keep the Fed on the sidelines, we expect yen to remain weak and weaken further if US yields break to new highs. That said, ongoing intervention to support the yen, our expectation for limited additional upside in US yields, and large short yen positions in the marketplace should limit further yen downside over coming months.
We expect another round of intervention as we approach 165 against the US dollar. Importantly, over the past two months, 2-year interest rates, two-year forwards — a proxy for future relative policy rates — have moved 0.57% in favor of the yen, while the yen continues to weaken. This suggests that the yen is becoming oversold and likely to enjoy a bounce higher in the near term, at least temporarily.
In the long term, we see a rally in the yen of around 20% over the next 2–3 years versus the US dollar (a fall in the USD/JPY exchange rate). This move is consistent with a compression in USD/JPY interest rate carry of 200–250 basis points and would take USD/JPY down to a level of 125–130 versus the US dollar from its current level in the mid-150s.
Swiss Franc (CHF)
Our models turned slightly positive on the franc versus the G10 average, entirely due to a negative flip in our commodity signal. Additionally, we hold a slightly positive view on the franc versus the euro, driven by better growth prospects and a persistent risk premium related to the French election.
Aside from the euro and commodity currencies, we are broadly negative on the franc in both our tactical and strategic models. It remains the most expensive G10 currency per our estimates of long-run fair value and has the second-lowest yields in the G10, and inflation is falling faster than expected.
With the real trade-weighted franc still at the upper end of its 30-year range — and the SNB both cutting rates and amenable to intervention to prevent excessive franc strength — we believe the franc is in the early stages of a prolonged reversion back down toward our estimate of its long-term fair value. This reversion will be only temporarily interrupted by a political risk premium.
Norwegian Krone (NOK)
Our tactical model signals flipped negative on the krone due to weaker commodity prices and poor local equity market performance. While economic indicators and the monetary policy outlook improved somewhat, they were not sufficient to maintain a positive signal. The fundamental growth outlook and expectations of higher-for-longer rates should help to limit downside risks. However, the krone is likely to remain volatile due to rising political risk, poor summer liquidity potentially triggering temporary corrections in equity markets, and consolidation in commodity prices.
In the long term, the outlook is more convincingly positive. The krone is historically cheap relative to our estimates of fair value and is supported by steady long-run potential growth.
Swedish Krona (SEK)
Our krona models shifted back into positive territory versus the G10 average due to improved economic data and a better outlook compared to commodity-sensitive currencies. However, this positive trend appears fragile. While it is promising to note better PMI numbers following last month’s upside surprise to Q1 gross domestic product (GDP). However, household consumption remains depressed, suggesting the upside inflation surprise may not persist. We believe the Riksbank’s projection of additional rate cuts should weigh on the krona.
Thus, we stress that the current positive signal is likely short-term (tactical), and we continue to see the krona lag against the US dollar over the next 1–2 quarters. The currency is very cheap to long-run fair value and cyclically depressed, but at this point we struggle to see a catalyst to provide a sustained rally.
Australian Dollar (AUD)
Our models shifted from near neutral to firmly negative due to a shift in our commodity signal. Rising global political risk, the weak Chinese Renminbi, and the strong US dollar all limit upside potential for the Australian dollar. In addition, there are positive factors that should mitigate downside risks for the Australian dollar. Despite sluggish economic growth, the economy is sluggish, but growth remains positive, inflation is higher than expected, and a large tax cut in the second half of year should provide support to domestic demand. This increases the chance of another rate hike supportive of the dollar in August. Therefore, while we are negative on the currency, we are not dramatically so and see potential for some additional upside should the official Q2 inflation print released in July surprise to the upside.
In the long term, the Australian dollar outlook is mixed. It is cheap against the US dollar, the British pound, the euro, and the Swiss franc, and has room to appreciate, but is expensive against the yen and the Scandinavian currencies. The Chinese story is less positive, with a structural downtrend in growth and a shift towards domestic consumption and higher value-added industries, which may gradually reduce the growth rate of Australian commodity export demand.
New Zealand Dollar (NZD)
We are negative on the New Zealand dollar over the near term. The benefit of New Zealand’s high yields is fully offset by ongoing challenges to growth and the weak external balance — the current account is –6.8% of GDP — and weaker commodity prices. The more hawkish tilt of the RBNZ is supportive, but that was largely reflected in the May rally. Meanwhile, poor growth and the medium-term trend of disinflation suggest that monetary easing will likely be necessary at some point this year. Thus, current policy rates at a healthy 5.5% should help limit the downside for the dollar, but they are not enough to prevent softness.
In the long 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 it is expensive against the yen and the Scandinavian currencies.
