US dollar’s flight to end as hawks squeeze out doves

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The US dollar appreciated against the euro and most emerging market currencies in 2019 despite decelerating growth and cuts in central bank policy rates. We do not see this continuing.

Over the last few months, a number of central banks have presented the market with a preview of forecasts that are less dovish than expected.

  • In November, the Reserve Bank of New Zealand kept policy rates on hold, while market participants had expected a 25bp rate cut.
  • In December, the policy rates of the Reserve Bank of Australia and the Bank of Canada remained on hold.
  • In Europe, the Riksbank raised its policy rates, marking an end to negative rates in Sweden.

More importantly, recent data from outside the US has been coming in ahead of market expectations. We believe this could mark an inflection point for the US dollar, and signal a weakening of the dollar in coming months.

Exhibit 1: Is the US dollar embarking on a weakening trend? – Graph shows changes in exchange rates for US dollar per euro (lhs; reverse) and US dollar versus emerging market currencies (rhs) for the calendar year 2019

fixed income outlook currencies

Data as at 3 January 2020. Source: FactSet, JPMorgan, BNP Paribas Asset Management

Weaker dollar allows yen and EM currencies to bounce back

On the flipside, in a weakening US dollar environment, we would expect the Japanese yen to reverse course and do well in the first quarter. A softer dollar is a tailwind for emerging market currencies too, and we expect them to turn in a strong first quarter.

Sterling, which was the most volatile of the major currencies in 2019, will probably have a leading role again in 2020. Despite the perception that Brexit will be done soon, many observers have remarked that the actual departure from the EU marks only the beginning of the end.

Fraught discussions with Brussels over the future relationship lie ahead. Just as sterling waxed and waned with every twist and turn in the separation negotiations, the question of whether the UK will ultimately extend the period in which it negotiates a trade deal or else risk the equivalent of a “no deal” break from the EU at the end of 2020 will swing the currency in similar fashion.

US growth at trend rate; Fed on hold

For 2020, US GDP growth is expected to stabilise near the trend rate. If that estimate is accurate, we would expect yields to move in a relatively narrow range from now on with the US presidential election, trade tensions, and inflation expectations becoming the key drivers.

With the signing of a “phase one” US-Sino trade agreement this month, there are hopes global trade and therefore global growth will recover. We do not believe, however, that there will be a significant reduction in trade tensions this year, either with China or with other countries.

The Federal Reserve is unlikely to change US interest rates until after the presidential election as GDP growth slows to trend, even though further cuts are arguably needed given that inflation is still below target. Voting is likely to result in a divided Congress unable to change spending, borrowing or taxation significantly. As a result, Treasury yields are likely to be most sensitive to geopolitical events, from the trade conflict with China to tensions in the Middle East.

Little scope for ECB action, or much fiscal stimulus, for that matter

In the absence of a recovery in global trade, and given the limited scope of monetary policy in the eurozone to boost growth, attention has turned on fiscal stimulus. However, in the country with the greatest potential to boost spending – Germany – the political and cultural inhibitions are significant.

It should also be noted that the wider economic impact of a German stimulus programme would be limited. It is not likely to change the outlook for the EUR 13 trillion eurozone economy. What is actually needed is economic and labour market reform. That still looks very unlikely.

We expect little change in monetary policy as the ECB spends most of the year focused on its policy framework review. While several central bankers in the eurozone might like to follow the Riksbank’s move to return to positive rates, the ECB has committed to not raise rates until after quantitative easing has ended. This ties its hands.

The most obvious investment risk is Italy. Elections could return the Lega party to power, sparking a renewed widening in Italian government bond spreads.

Flows should support emerging market currencies

We believe that the strong US versus weak EM cycle could reverse in 2020. With the Fed on hold and generally benign inflation globally, EM central banks should generally be able to continue, or even expand, their accommodative fiscal and monetary policies. Growth should rebound from currently depressed levels. This should prompt flows into EM assets, and that bodes well for EM currencies.


This is an extract from our fixed income outlook for the first quarter of 2020


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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Dominick DeAlto

Chief Investment Officer, Fixed Income

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