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Fixed Income Outlook  |  Q3 2018

Currency views

Fixed Income Team


U.S. dollar on an upward trend

The U.S. dollar remains supported by a steady dose of hawkish Fed expectations, while other global central banks have flinched. The more structural aspects of a weaker U.S. dollar (the twin deficits — the fiscal deficit and current account deficit — and reserve diversification of foreign central banks) remain intact but will only act as a headwind to a stronger U.S. dollar broadly. A recent flare up in Italian politics serves as a reminder that the dollar still benefits when flight to quality occurs. Given the risks of U.S. trade policy and European politics, the dollar is still subject to abrupt appreciation pressures. However, with the dollar being richly valued and the economic cycle in its later strategies, dollar rallies are likely to be sold.

Italy may cause headwinds for the euro

The outlook for the euro remains dominated by relative monetary policy, robust growth, and euro political risk premium. The ECB announced in June it will end asset purchases in December, and it enhanced its forward guidance for the first-rate hike to take place after summer of 2019. This has helped to perpetuate the monetary policy divergence theme relative to the Fed. Inflation — headline and core — should start to pick up in the coming months and growth should stabilize. Politics in Italy, which is led by a populist coalition, will remain a headwind for the euro, as Italy is too big to fail, and fiscal promises are likely to generate political backlash from Brussels. If a palatable political path is established, the single currency should stabilize and appreciate.

The pound is likely to remain weak

In the United Kingdom, political concerns have fallen as quickly as they re-emerged. The EU summit accomplished a transition agreement that will apply from the end of March 2019 to the end of 2020. The probability of a soft Brexit continues to increase. The Bank of England expectations remain in flux as inflation data had been soft, but signs of a growth pickup are emerging. Sterling is likely to remain weak until growth, both domestic and global, begins to improve.

Yen may drift higher on politics, current account surplus

At its most recent meeting, the Bank of Japan kept its yield curve control settings unchanged and pledged to "continue current powerful monetary easing persistently," while also lowering its inflation forecasts. Structural forces will start to play in favor of the Japanese yen. The large current account surplus coupled with a very weak yen suggest that the U.S. dollar should drift lower versus the yen over the medium term. Additionally, if mounting scandals force Prime Minister Abe to step down ahead of the ruling LDP leadership contest in September and Abenomics comes into question, it's likely the yen would appreciate significantly.


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Fixed Income Outlook represents the views of Putnam's senior investment leaders.

D. William Kohli
CIO, Fixed Income

Michael V. Salm
Co-Head of Fixed Income

Paul D. Scanlon, CFA
Co-Head of Fixed Income