Fixed Income Outlook  |  Q4 2019

Currency views

Fixed Income Team

Currency views

The dollar to remain supported

The dollar's support from its high-yielding status is wavering. The Federal Reserve lowered its policy rate twice during the quarter to a range of 1.75% to 2.00% to cushion the economy against a slowdown. However, Fed officials are less dovish than expected by the markets and continue to signal a high level of dependency on data. The Fed also remains divided on how to set future policy. Growth outside the United States will need to pick up to allow a more broad-based dollar depreciation. The trade rift between the United States and China has created downside risks, with breakthroughs unlikely ahead of the elections in 2020. So, the dollar will likely remain supported against most other currencies except for the Japanese yen, the Swiss franc, and maybe the euro.

Euro depreciation may be capped

The outlook for the euro remains dominated by monetary policy, growth, and the currency's political risk premium. The ECB recently cut its deposit rate, introduced tiering of reserves to limit the impact of negative rates on the banking system, enhanced forward guidance, and restarted the QE program. The emphasis is on keeping policy easy until inflation reaches the ECB's target. This promises low rates and asset purchases for as long as necessary. The euro will likely retain its role as a funding currency. However, there are limits to how low the single currency can go as other central banks shift to a more dovish tone.

Brexit fog looms over the pound

In the United Kingdom, Brexit still determines the direction of the pound sterling. Political uncertainty remains high. Parliament has passed legislation that requires Boris Johnson's government to extend the United Kingdom's exit deadline to avoid a no-deal Brexit on October 31. Pushing the required deadline to the end of January 2020 means the fog is unlikely to lift any time soon. And as such, the country is also highly likely to face an election, with the polling day as soon as late November. All of this is likely to delay any policy action by the Bank of England until at least the first quarter of 2020. Sterling will be subject to swings in the polls for the general election.

Japan's yen and near-term stimulus

The Bank of Japan (BoJ) and its governor Haruhiko Kuroda have indicated that more accommodative policy is an option amid soft global growth, trade risks, and the recent increase to the value-added tax. At its September meeting, the BoJ mulled several policy options, including lower rates, a higher QE program, and accelerating the increase in the monetary base. So, there are glimmers of hope for changes in policy — in line with other global central banks — as early as October. However, the impact on the yen is likely to be limited and temporary. As other central banks have cut rates and as markets have priced in lower rates, the interest-rate spreads with Japan have narrowed. That has reduced Japan investors' tendency to seek higher yields abroad. We expect the yen to remain strong.

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