Fixed Income Outlook  |  Q1 2019

Currency views

Fixed Income Team

Currency views

The dollar may stabilize

At its December meeting, the Federal Open Market Committee (FOMC) hiked rates by 25 basis points. The FOMC also lowered its median expectation for interest-rate hikes in 2019 from three to two. Powell emphasized the FOMC will rely on data to decide on rate increases but would continue to follow plans to reduce its balance sheet. The market was expecting a significantly more dovish outcome, and risky assets weakened following these statements. Since then, Powell and other Fed speakers have softened their tone and implicitly signaled a pause to the rate-hike cycle. Powell has also indicated that balance sheet policy could change if conditions warrant. This should help to alleviate some of the upside pressure on the U.S. dollar coming from Fed policy.

Risk-off market sentiment caused most of the yield curve to rally
and flatten during Q4 chart

The euro also looks steady

The outlook for the euro remains dominated by monetary policy, growth, and political risk premium. Expectations for higher inflation have been pushed back because of recent low oil prices. Some aspects of core inflation have proven weaker than expected. While the ECB ended its asset purchase program in December, it also revised down its growth and inflation forecasts. This, in turn, justified expectations that the ECB would delay its first-rate hike until after the summer of 2019, or early 2020. The delay in the rate hike should limit how much the single currency can rally on a weaker dollar.

Brexit weighs on the pound

In the United Kingdom, Brexit noise remains high. Prime Minister May survived a no-confidence vote. This step prevents another challenge to her leadership for the next 12 months. The European Court of Justice determined the United Kingdom can revoke the Article 50 process, the step it took to initiate Brexit. This decision significantly reduces the likelihood of Brexit occurring without a new arrangement between the United Kingdom and the European Union. While considerable work on an arrangement remains ahead and may continue to cause market volatility, a soft Brexit is now the most likely outcome. While this uncertainty remains, the pound's appreciation will likely be limited.

Japan adjusts policy

The Bank of Japan (BoJ) changed its yield curve control (YCC) policy in August. It allows for an elongated policy horizon driven by focusing on the price (level) of rates over quantity. At subsequent meetings, the BoJ continued to endorse this policy. With Japan's growth and inflation moving lower, it's likely that policy will remain accommodative even longer than previously expected. The risk to this outlook is if the YCC and negative interest rate (NIRP) become more damaging to regional banks. This could alter the flow of credit to the real economy, a risk that could lead to further tweaks in YCC.

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The outlook for global growth in 2019 has slipped because of rising real interest rates, trade tensions, and asset market volatility.