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US dollar: Neutral.
We believe the dollar is caught between two macro trends. On the one hand, US growth has positively diverged from the rest of the world, leading to increased interest rate differentials. Higher growth and larger interest rate differentials are typically positive for the US dollar. On the other hand, the US is running large budget and current account deficits. We believe these dueling factors will keep the US dollar in a holding pattern in the near term, but we expect the budget and current account imbalances to eventually drive it lower.
While growing more positive on the euro, we still remain on the sidelines. Most of the macro factors that have driven the euro weaker against the US dollar appear to be fully priced, in our view. Italian politics are the main unresolved headwind for the euro, but we expect a benign outcome.
The renminbi/US dollar exchange rate traded between 6.90 and 6.95 for most of October1 but broke above this range late in the month and has since traded between 6.95-6.98.2 US-China politics and trade-related headlines are expected to continue pressuring the pair’s performance. In addition, we see the performance of the US dollar against other major currencies as another major driver of the renminbi/US dollar exchange rate. Capital controls on outflows remain tight, but financial opening will likely continue to increase overseas demand for China onshore assets. We still see 6.80 to 6.90 as the likely trading range, and expect policy intervention if the exchange rate moves towards 7.0.
Japanese yen: Overweight.
Despite generally higher global bond yields, the yen appreciated versus the US dollar and the euro in October. In our view, this was caused in part by risk aversion related to the selloff in US equities and Italian government bonds. The market had built up large short yen exposure, and its reversal has probably been driven by short covering. Taking a longer-term view, because we believe the yen remains cheap and is often considered a “safe-haven” currency, it may be an attractive counterbalance to risk assets.
British pound sterling: Neutral.
Sterling has rallied around 1.5% on a trade-weighted basis this month, reflecting increased optimism that a deal can be agreed with the EU at the December European Council meeting.3 However, this optimism may have run ahead of reality. There are few signs that the impasse over the Irish border backstop has been resolved. Even if the UK government succeeds in reaching an agreement with the EU, it still faces the difficult task of getting parliament to ratify its proposal. Ultimately, we think an agreement with the EU will be reached and the proposal will be ratified, but the situation is unpredictable and, consequently, we prefer to maintain a neutral position.
Canadian dollar: Neutral.
The Canadian economy has performed reasonably well this year with GDP growth and inflation near 2%.4 The Bank of Canada (BOC) continues to believe the economy is at capacity and is hiking interest rates gradually. Recent news of the new trade agreement with the US, Canada and Mexico failed to produce more than a brief bounce in the Canadian dollar, and the currency traded weaker over the last month. However, a shift toward a more hawkish tone from the BOC should provide some support.
Australian dollar: Underweight.
The Reserve Bank of Australia (RBA) kept its policy rate stable at the October meeting. While it has commented that the next move will likely be an increase, the RBA also stated there is no strong case to raise interest rates in the near term. As the RBA continues to hold rates stable while the Fed increases the US policy rate, the interest rate differential between the two countries rises, putting further downward pressure on the Australian dollar. The trade war between the US and China shows no signs of abating and could also pressure the Australian dollar, especially if the situation intensifies.
Indian rupee: Neutral.
The rupee has experienced a significant selloff this year, especially in the last several weeks, depreciating 12.9% year-to-date against the US dollar.5 This was largely driven, in our view, by an increase in crude oil prices, foreign portfolio outflows and a higher current account deficit. Although we believe risks are still skewed to downside for the rupee, we are hesitant to move underweight at current levels. This is partly because the Reserve Bank of India has apparently intervened in the currency market in recent weeks (as evidenced by the decrease in its US dollar reserves). Further intervention could limit future declines in the rupee.
1 Source: Bloomberg L.P., Oct. 1, 2018 to Oct. 28, 2018.
2 Source: Bloomberg L.P., Oct. 29, 2018 to Oct. 31, 2018.
3 Source: Deutsche Bank GBP Trade Weighted Index, Oct. 1, 2018 to Oct. 19, 2018.
4 Source: Statistics Canada, Consumer Price Index, Oct. 19, 2018, Gross Domestic Product, Sept. 28, 2018.
5 Source: Bloomberg L.P., Oct. 19, 2018.
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Gross domestic product is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time.
Safe havens are investments that are expected to hold or increase their value in volatile markets.
The current account records a nation’s transactions with the rest of the world – specifically its net trade in goods and services, its net earnings on cross-border investments, and its net transfer payments – over a defined period of time, such as a year or a quarter. A positive current account balance indicates that the nation is a net lender to the rest of the world, while a negative current account balance indicates that it is a net borrower.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
Ray Uy, CFA
Head of Macro Research and Currency Portfolio Management
Raymund Uy is Head of Macro Research and Currency Portfolio Management for Invesco Fixed Income.
Mr. Uy has been in the industry since 1993. He has experience in a variety of functions, including global fixed income trading and portfolio management; currency trading and portfolio management; credit research and macroeconomic analysis.
Mr. Uy worked at Hartford Investment Management (HIMCO) for eight years prior to joining Invesco in 2012. At HIMCO, he was a lead portfolio manager for non-US-dollar-based fixed income portfolios, and as head of Fixed Income Trading, he managed a centralized platform of traders across multiple fixed income sectors. Before joining HIMCO, Mr. Uy spent six years at Mackay Shields in New York and five years at Fiduciary Trust.
He earned a BBA from Hofstra University in New York, and is a CFA charterholder.