Fixed Income Outlook  |  Q4 2020

Currency views

Fixed Income Team

Currency views

The dollar is losing its luster amid slide

The dollar's support from its high-yielding status has disappeared as the Fed slashed rates to zero and unveiled an unlimited quantitative easing (QE) package. The Fed's new policy framework also means a lower-for-longer short-term policy rate. The death of Supreme Court Justice Ruth Bader Ginsburg and the race to confirm a successor suggests an agreement on a near-term fiscal package could be delayed. The global recovery and the COVID-19 pandemic will continue to be key themes for the dollar, but the election will be the dominant theme. The candidates' platforms cast very different outlooks for fiscal policy and globalization. The dollar will likely be volatile as polls swing and until a clear winner emerges in the presidential vote.

The euro is on an uptrend

The outlook for the euro remains dominated by monetary policy, growth, and political risk premium. The ECB is concerned about the euro's strength since it could weaken growth and the inflation target. The ECB could increase asset purchases via the Pandemic Emergency Purchase Programme (PEPP), but it is not clear this will be negative for the euro. The European Recovery Fund is a fundamental game changer for the eurozone over the medium to the long term. This and the ECB's massive asset purchases should keep bond spreads tighter in peripheral countries. As COVID-19 cases trend higher in some economies, there is a tempering of upside expectations for the euro. Still, we expect the currency to trend higher.

British pound to remain volatile

The government has proposed trade legislation that would violate the withdrawal agreement with the EU. The bill, which has to be approved by the U.K. Parliament before becoming law, would contravene an international treaty. It is unclear whether this is purely a negotiating tactic to placate backbenchers in the Conservative Party or to pressure the EU for additional concessions. It is a risky move by Prime Minister Boris Johnson. This makes the next several months highly volatile for the pound. A no-deal Brexit scenario would see the pound depreciate over the medium term, and a last-minute deal would see the pound rally in the near term until other factors begin to dominate its direction.

Japan's yen likely to appreciate

Yoshihide Suga was elected the new prime minister following a vote in Parliament in mid-September. Suga, who will head the ruling Liberal Democratic Party, is expected to continue former Prime Minister Shinzo Abe's policies. Abenomics represented Japan's attempt to break away from two decades of lackluster growth and deflation. Suga will face a more difficult environment. The Bank of Japan is largely sidelined with limits on additional monetary easing and remains focused on ensuring that bond yields remain low. As purchases of foreign equity abates and outward direct investment from Japan slows, we should see the yen climb higher.

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