Fixed Income Outlook  |  Q1 2023

Currency views

Putnam Investments

Currency views

Dollar to trend down

With inflation moving in the right direction, any softening in the labor market data should be key to the near-term trading of the U.S. dollar. At some point, the Fed may be forced to respond to the loosening in financial conditions, but for the time being, the message is likely to be more balanced. And as such, it's likely we've seen the highs in the U.S. dollar. Meaningful rallies in the U.S. dollar will be opportunities to sell for expected weakness later in the year.

Euro has more support

The European Central Bank (ECB) is in similar circumstances as the Federal Reserve. It's likely to step down the pace of rate hikes, for while inflation is incredibly high, it may have peaked. Meanwhile, the labor market remains very tight. For the euro, positioning remains short. The energy story in the near term is less negative, and the global growth backdrop should be supportive, driven by a better outlook for China. The lows for the single currency appear to be in place, but data in this environment are noisy, which should create tradable ranges in the near term. Meaningful dips will be opportunities to buy.

The pound is past its low point

The Bank of England appears hesitant to be more hawkish than other central banks, but like the ECB, it too must face higher-than-expected inflation and tighter labor markets. This suggests tighter policy than previously envisioned. With a more supportive global backdrop in the near term and less consternation from fiscal policy, the pound has seen its lows. It remains cheap to its longer-term valuation, so meaningful dips should be opportunities to buy.

Japan prepares for yield surge

The Bank of Japan (BoJ) was the policy outlier. At its December meeting, however, it made an announcement of a modification of its yield curve control (YCC). It will widen the YCC range to +/–50 bps around 0%, from +/–25 bps earlier. On top of its daily unlimited fixed-rate purchase operation, the BoJ also announced an increase in the amount of bonds it will regularly buy under a competitive auction method in the first quarter of 2023. The purpose is to prepare for any potential surge in yields. While described as a solution to poor bond market functioning, the market will likely expect more changes in policy over the coming months and quarters, especially with Governor Kuroda stepping down in April. As such, rallies in dollar-yen rates are likely to be sold due to Fed/BoJ policy reconvergence and as expectations of recession risk for 2023 rise.

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