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US dollar: Underweight.
We expect the US dollar to weaken in the near term. Renewed global growth convergence will likely cause the unwinding of the US exceptionalism theme that drove the dollar higher in 2018. We are encouraged by the price action so far this year and believe it is appropriate to re-establish an underweight in the dollar in the first quarter of 2019. US growth should remain solid in 2019, but moderate toward a mid-to-low 2% level as the Fed reaches the end of its tightening cycle. In Europe and China, we expect growth to stabilize above potential in 2019, which could cause investors to shift some assets from the US to other regions, potentially weighing on the dollar. Budget and current account deficit concerns could be additional headwinds for the dollar.
We remain on the sidelines but are more optimistic given the change in our broader US dollar view. While we expect further convergence across the global economy over the course of this year, euro area activity continues to moderate, and it seems unlikely that the European Central Bank will implement a favorable policy catalyst. Thus, any positive drivers for the euro will likely be due to exogenous factors as the year unfolds.
The renminbi rallied to a range of 6.75 to 6.80 in January, helped by US dollar softness and more encouraging headlines on US-China trade negotiations.1 We expect US dollar performance against other major currencies and US-China trade relations to continue to drive the renminbi’s performance versus the US dollar in the near term. Chinese capital controls on outflows remain tight, which should give the Peoples Bank of China room to pursue independent monetary policy. We still view 6.80 to 6.90 as the likely trading range for the renminbi.
Japanese yen: Overweight.
The yen appreciated sharply in late December and early January, finally exhibiting its historic negative correlation to risk assets. Due to the limited upside to US yields, slowing global growth and rising volatility, the unhedged foreign exchange flows that acted as a headwind for the yen in 2018 are likely to wane or reverse, in our view. Although the yen has rebounded from its lows, we believe this reversal will allow the currency to act more as a risk-asset hedge going forward. We are likely to add to our existing yen position on dips.
British pound sterling: Overweight.
Although the tail risk of a “no deal” Brexit remains, there is increasing evidence that a cross-party coalition of members of Parliament is mobilizing to avoid this outcome. The European Union (EU) also appears willing to extend the deadline for leaving the EU beyond March 29. In addition, we view the huge defeat of Prime Minister Theresa May’s deal and the Labour Party’s failure to force an election as increasing the probability of a softer Brexit model. These could include a permanent customs union, a customs union and single market membership (the so-called Norway plus model) or a new referendum.
Canadian dollar: Neutral.
The Canadian dollar ended 2018 at a low but has since rallied to begin the year.2 The rally occurred despite the Bank of Canada’s switch to a dovish tone at its January meeting, where it indicated a willingness to be patient and watch for a pickup in the data. With the recent rebound in the Canadian dollar, the currency is nearing a level where we may consider moving underweight.
Australian dollar: Neutral.
The Australian dollar has exhibited its historical positive correlation to global risk sentiment, depreciating in December and appreciating in January. The currency appears undervalued relative to Australia’s terms of trade, in our view, and could benefit from Chinese stimulus and easing US-China trade tensions. However, Australia’s relatively weak domestic growth and inflation picture, combined with monetary policy stability, will likely keep the Australian dollar range-bound.
Indian rupee: Neutral.
The rupee has appreciated nearly 4.5% against the US dollar since it reached an all-time low of 74.44 in October 2018.3 It is likely this rebound was driven largely by declining oil prices and supportive measures from the Reserve Bank of India (RBI). However, we believe the RBI is unlikely to provide additional support and any further appreciation will likely be driven by moves in the US dollar or oil prices.
1 Source: Bloomberg L.P., data from Jan. 1, 2019 to Jan. 24, 2019.
2 Source: Bloomberg L.P., data from Dec. 31, 2018 to Jan. 18, 2019.
3 Source: Bloomberg L.P., data from Oct. 9, 2018 to Jan. 18, 2019.
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A hedge is an investment made to reduce the risk of adverse price movements in a security by taking an offsetting position in a related security. To be “unhedged” is to not have this offsetting position.
Tail risk generally refers to events which have a very small probability of occurring. In finance, it is when the possibility of an investment moving more than three standard deviations from the mean is greater than what is shown by a normal distribution.
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.