Fixed Income Outlook  |  Q2 2023

Currency views

Putnam Fixed Income team

Currency views

The dollar is likely to weaken

The dollar's course may be shaped by U.S. Federal Reserve decisions. The Fed now has more to consider with recent bank turmoil and the prospect that financial conditions will tighten due to tighter credit as well as higher policy rates. The ongoing consternation in the markets will likely lead to wider trading ranges for the U.S. dollar. We believe we have seen the highs in the U.S. dollar, and meaningful rallies will be opportunities to sell the greenback for continued expected weakness.

Adding euro exposure is attractive

The European Central Bank (ECB) is in similar circumstances as the Fed but is earlier in its path toward policy normalization through rate increases. Like the Fed, the ECB has suggested a desire to slow down the pace of hikes. Data has challenged this thesis, as inflation has peaked but is not falling as quickly as desired. Meanwhile, the labor market remains very tight. The energy situation 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 euro appear to be in place, but data in this environment are noisy. This should create tradable ranges for the euro in the near term. We believe dips will be opportunities to buy.

For the British pound, the worst is likely over

The Bank of England (BoE) appears hesitant to be more hawkish than other central banks. Like the ECB, the BoE 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, we believe the pound has seen its lows. It remains cheap to its longer-term valuation, so meaningful dips should be opportunities to buy.

Yen may see better policy support

The Bank of Japan (BoJ) had been the policy outlier for some time but has begun policy normalization. At its December meeting, the BoJ announced a modification of its yield curve control (YCC) policy, widening the YCC range to +/–50 bps around 0%. The range had been +/–25 bps earlier. Since that meeting, the BoJ was much more measured. This disappointed a hawkish market. In addition, Governor Kuroda has retired and has been replaced by Dr. Kazuo Ueda. While the market reaction to his nomination was dovish, that is likely because the alternatives were more hawkish. It is still important to note the new leadership, including two new deputy governors, is more hawkish than the outgoing leadership. This should lead to gradual changes in policy, which should be supportive of the yen. As such, rallies in the dollar-yen exchange rate are opportunities to sell the dollar, we believe, due to Fed/BoJ policy reconvergence.

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