Fixed Income Outlook  |  Q4 2018

Currency views

Putnam Investments

Currency views

U.S. dollar buoyed by rate hikes

In the United States, growth remains stable and inflation firm. Globally, growth has cooled, and inflation pressure is more subdued, although it appears we are seeing signs of bottoming, particularly in Europe. In these conditions, the U.S. dollar remains supported by a steady dose of hawkish Fed expectations at a time when other global central banks remain cautious. The more structural aspects of a weaker U.S. dollar story (the twin deficits of the federal budget and the U.S. current account, along with reserve diversification) remain intact and will likely dominate over the medium term but will only act as a headwind to a stronger U.S. dollar broadly.

Euro outlook tied to Italian politics

The outlook for the euro remains dominated by relative monetary policy, growth, and the euro political risk premium. Inflation should start to pick up in the coming months (headline has, and core should follow) and growth should continue to stabilize at lower but robust levels, both of which should limit the downside in the single currency. The continued disruption from Italian politics and budget negotiations will remain a headwind to significant upside for the euro as Italy is too big to fail and fiscal promises are likely to generate political backlash from Brussels.

The pound’s appreciation likely capped

In the United Kingdom, Brexit noise remains high. A relatively “soft” Brexit remains the most likely outcome. However, the possibility of no deal remains. This uncertainty is on the radar of Bank of England Governor Mark Carney, who has stated that the variance around possible Brexit outcomes had risen. But he also emphasized that it was not prudent for the Monetary Policy Committee to wait for “perfect certainty” on Brexit before adjusting monetary policy. With that, the bank hiked rates by 25 bps to 0.75%. The British pound will likely be limited in terms of its upside as the market will continue to discount the Bank of England’s modal path of rate hikes, with Brexit uncertainty requiring a higher risk premium.

Japan’s yen may trend higher

The BoJ changed its yield curve control policy in August, allowing for an elongated policy horizon driven by focusing on the price level of rates over quantity. In the medium term, structural forces will start to play in favor of the yen as the large current account surplus and favorable valuation suggest that the dollar-yen rate should drift lower, but it is subject to trade higher over the coming months.

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