Fixed Income Outlook  |  Q1 2018

Currencies influenced by central banks moving at different speeds

Fixed Income Team

Currencies influenced by central banks moving at different speeds

The dollar may rally a bit longer

The U.S. dollar outlook continues to be most heavily influenced by the Fed and Congress' surprising ability to deliver a tax reform package. At its December meeting, the Fed hiked rates by 25 bps, as largely expected by the markets. The market is pricing another 50–60 bps in hikes in 2018, a level still a little below the Fed's economic projections, or "dots" outlook, but this gap has closed quite a bit over the past several months. With Jerome Powell approved by the Senate Banking Committee to be the next Fed Chair, it suggests policy continuity over the medium term. Over the coming months, the tactical U.S. dollar rally may continue, though it has already started to wane as the dollar is quite rich.

The euro appears stable

The outlook for the euro remains dominated by relative monetary policy, better-than-expected growth, and a diminished euro political risk premium. The ECB continues to balance the doves, who point to tame core inflation rate, with the hawks, who call for tapering and then ceasing asset purchases. The euro has already moved considerably, so much of the near-term direction will be based on whether the ECB is dovish or hawkish relative to the Fed.

Brexit negotiations to influence the pound

In the United Kingdom, the discussions over Brexit remain fluid and quite noisy, contributing significant volatility to the British pound. Unless there is a breakthrough in negotiations, this volatility is likely to persist. The statements from the Bank of England have been surprising. The BOE has hiked rates for the first time in ten years (by 25 bps) and backpedaled on expectations that only a couple of hikes would be necessary over the coming three years, putting the fate of the pound firmly back on to Brexit negotiations.

Yen to remain soft as capital leaves Japan

With Prime Minister Abe's landslide victory in the October election, the tail risk of the end of "Abenomics" has been dramatically reduced. Bank of Japan (BoJ) Governor Kuroda continues to underscore that the inflation outlook remains subdued and, as such, the market should not expect any change in BoJ policy, adding that there was no need to raise rates just because foreign rates rise. The dollar-yen rate will remain a function of Fed policy and the long end of the U.S. Treasury yield curve. With financial market volatility low, the yen should continue to soften as capital leaves Japan to be invested in higher-yielding assets abroad.

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The acceleration in global growth witnessed in 2017 should continue well into 2018, we believe, but likely with significant changes in its components.