| Speed Bumps on the Global Recovery | In this week’s podcast, David Atkinson talks with FX Head Trader Richard Pontius about some of the recent events in markets and international business. While the global recovery seem to pick up speed, it is not all balanced. - Congestion at US ports have been one of the key problems in the US supply chain
- Rising US yields are distinguishing the USD from many other currencies
- Countries that are at the beginning of the global production system are seeing their currencies in high demand, even while the USD continues to rally against most of its rivals.
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One- to two-week view: The euro is expected to be on the weaker side due to a variety of factors. First, the European Central Bank (ECB) pushed back against recent increases in yields by announcing a faster pace of PEPP purchases. Second, the number of COVID-19 cases is increasing again, with multiple countries moving to some tougher measures. Moreover, while countries have restarted using the AstraZeneca vaccine, questions around its safety could have a lasting impact on people’s willingness to receive it, increasing the gap between the eurozone and the U.S. and U.K. Third, elections in the euro area introduce some tail risks, as illustrated by the poor showing from German Prime Minister Angela Merkel’s ruling CDU party, which doesn’t bode well for the upcoming general elections. This all nets out to an expectation for European growth (PMIs out this week) to continue lagging U.S. growth and for the ECB to remain more concerned over rising yields than the Federal Reserve.
Three- to six-month view: Heading into the year, we questioned the euro’s ability to continue strengthening, as many factors (valuation, yield compression, removal of sovereign risk) have faded. If anything, aggressive fiscal stimulus in the U.S. only adds to euro pressure, as it sharpens the difference in U.S. and European growth. Notably the U.S. lost less output than the Euro area through the pandemic, and the U.S. fiscal response has also been stronger. Case in point, the U.S. is sending out stimulus checks worth 2% of GDP, while Europe is contending with slower vaccinations and constant pushbacks on when economies will reopen. Finally, on monetary policy, the ECB has committed to a significant increase in PEP purchases and has understandably shown more concern for financial conditions than the Fed, leading to policy divergence that should pressure the euro. | |
One- to two-week view: The Bank of England (BoE) met this past week and kept rates on hold as expected. The BoE also did not push back against a rise in yields, as it views the rise as reflecting a better outlook. Good vaccine progress, an overall improvement on the COVID-19 situation and a larger-than-expected fiscal package all bring upside risk to British pound forecasts. Given this, relative vaccine outperformance has largely been priced in, and the BoE struck a more cautious tone at its last meeting on the economic outlook that reflects elevated economic uncertainty. Lastly, tensions between the U.K. and EU remain, as trust on both sides continues to deteriorate post-Brexit, representing downside risks. The labor market report and PMI data are the key releases. Overall, the pound is expected to hold steady.
Three- to six-month view: The building block for the pound’s outperformance remains the same as it has been all year. The U.K.’s effective vaccine rollout program gives the country a good head start relative to other developed market countries in reaching the herd immunity needed for a sustained relaxation of lockdown measures. Additionally, the recent budget delivered a surprisingly large increase in fiscal support that turned fiscal measures from a headwind to a tailwind. Given this, there are reasons to remain cautious. The first reason is that the economy isn’t moving ahead of its peers but simply catching up to them. The second is that while vaccines helps relative near-term economic outperformance, they won’t impact the sustained trend rate of growth that is more relevant to the medium-term outlook. Recent economic data made clear how disruptive Brexit has been to trade. While levels should recover as business gets adjusted to the rules, the point is that Brexit will have a negative effect. So while the U.K. economy is fast out of the gates, questions remain about its stamina. | |
One- to two-week view: Recent USD/JPY underperformance reflected not only the general risk-on trend but also the view that the Bank of Japan’s (BoJ) policy review will only deliver minor adjustments, which turned out to be the case, as the bank introduced changes widely in line with expectations. As such, USD/JPY should remain driven by the reflationary narrative that points to yen weakness as overseas yields come under increasing upward pressure while Japanese yields remain suppressed by yield curve control. To the extent that an extended state of emergency leads to a sharper deceleration in economic activity (PMIs out this week), the BoJ will be pushed toward dovishness, making the speed of vaccine rollouts, which started later than Japan’s peers, important.
Three- to six-month view: The sharp rise in yields during the back half of February through the first half of March necessitates a lift up of yen target rates. While the yen will be influenced by the direction of nominal rates in the near term, the medium-term outlook remains downward sloping, with moderate yen outperformance versus the dollar still expected. This view reflects Japan’s underlying balance-of-payment strength, relatively cheap valuation and real rate advantage. The trend of Japanese portfolio flows will also be important, as the good part of the yen’s cheap valuation came from unhedged outflows over the past couple of years. Rising crude prices should also weigh on Japan’s trade balance, but the current account is still expected to remain in a comfortable surplus. Given this, a delayed reopening will likely erode Japan’s trade surplus and weigh on the currency. | |
One- to two-week view: The Bank of Canada (BoC) stuck to its script and reinforced its forward guidance despite better-than-expected economic data. Given this, strong labor market data continues to point to the possibility of earlier tightening. While the Canadian dollar (CAD) remains susceptible to global risk sentiment and broad dollar moves, CAD outperformance is still expected, as the economy has been resilient (strong labor market report) and the country scores well on high vaccine procurement and falling case numbers. Additionally, the currency should also receive support from the OPEC+ supply cut extension.
Three- to six-month view: The CAD outlook remains bullish due to continued Canadian growth surprises with an incoming wave of U.S. fiscal stimulus, the rising likelihood of BoC tapering and commodity sector outperformance that supports Canada’s terms of trade. In essence, the CAD offers both U.S. dollar–proxy qualities and pro-cyclical exposure. With economic data outperforming BoC projections, the bank will likely have to address taper at its April meeting. Regarding U.S. stimulus, the unique composition of fiscal support could cloud how much the Canadian export sector benefits, but it will receive a boost. Moreover, the correlation between U.S. and Canadian rates illustrated the economic links between the two countries as well as similar central bank reactions to rising yields. The OPEC+ decision to hold production flat also benefits the CAD. On the negative side, Canada’s inability to manufacture vaccines domestically means it is lagging peers on deployment, making it vulnerable to a slower reopening and a more dovish BoC. | |
One- to two-week view: China’s economic data has turned more mixed but continues to be robust on balance. Relative economic outperformance, a current account surplus and relatively high yields still form the base for a bullish Chinese yuan (CHY) view. Eventually, COVID-19 vaccine distribution will allow the rest of the world to close the growth gap, but for now, China’s yield advantage and foreign investor inflows support further gains. On the geopolitical front, the U.S. and China held their first face-to-face meeting since Joe Biden became president. Media reports described the meeting as contentious, but with the event being as much political as business related, posturing was not unexpected. The hope is that this meeting will pave the way for a April meeting between Presidents Joe Biden and Xi Jinping and possible tariff reductions.
Three- to six-month view: The yuan has proven to be less sensitive to rising U.S. yields relative to developed market currencies. This result is in line with historical data that shows interest rate differentials as not a significant driver of USD/CNY due to central bank oversight and tight capital controls that negate the effect of interest rate differentials. However, the significant rise in U.S. yields cannot be entirely ignored. China’s export sector continues to outperform and should benefit from the continued global recovery and associated increase in goods demand. On the capital front, continued interest in reallocation of funds into Chinese bonds from global fixed-income investors should mean durable bond inflows, even amid a global bear market for bonds. Overall the yuan still enjoys a constructive medium-term backdrop, but further gains will be hard to come by due to a more constructive U.S. dollar outlook. | |
One- to two-week view: The Australian dollar’s (AUD) correlation to risk sentiment and yields should keep volatility high, although the currency’s relationship to risk should lessen as the Reserve Bank of Australia (RBA) continues its push against higher AUD rates. To this point, RBA Governor Philip Lowe has re-established RBA as one of the few G10 central banks that have taken action against a rise in yield. While the central bank refrained from saying the AUD is overvalued, the bank did note that it would like to see the currency lower. On the economic front, the labor market continues to outperform expectations; however, the RBA’s asset purchase program and expectations for U.S. exceptionalism are making it difficult for the AUD to do well.
Three- to six-month view: Idiosyncratic issues, such as a negative AUD-USD rate spread and a central bank that is actively pushing against rising yields, should see the AUD drift lower over the medium term. Iron ore accounts for a significant portion of Australia’s exports. Thus far, iron ore prices have been a support, but pressure on Chinese steel margins should see a drop in production demand. On the yield front, U.S. yields are around the point at which the relationship between the U.S. dollar and yields turns positive, meaning any further rise in yields should be dollar positive. Speaking of yields, the central bank knows that reflationary spillovers like higher rates and unwarranted currency appreciation can disrupt the recovery. As such, the RBA has proven itself to be one of the few central banks willing to push back on rising rates. Not only has the bank increased its asset purchase program, but it has shown a willingness to target purchases toward the most relevant part of the yield curve. | |
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