The Canadian dollar has bounced around since the U.S. presidential election as economic growth has shown positive signs but inflation continues to disappoint the Bank of Canada (BoC). It sold off initially after the Fed raised rates in December, but rallied back strongly after year end. The BoC stated at its January meeting that rate cuts are still a possibility, but it will likely wait until more clarity is available on U.S. fiscal and trade policy before taking action. The Canadian dollar remains overvalued, in our view, but will likely trade within a range in the near term.
See below for the Invesco Fixed Income team’s outlook for the key world currencies.
A resumption of the Fed’s hiking cycle is bullish for the U.S. dollar, in our view. Global yield differentials currently favor U.S. asset markets and should drive capital flows into the U.S., benefiting the U.S. dollar. The pace of U.S. dollar appreciation is likely to be slower than in 2015 and 2016, unless foreign central banks begin easing again. The Trump administration’s tax and trade agenda is likely to cause significant currency volatility.
While we continue to expect further euro weakness as the chances of tighter Fed policy increase, we are cautious given crowded investment positioning and prospects for additional political uncertainty to weigh on risk sentiment across asset markets. We have reduced our risk positions accordingly as we evaluate fresh catalysts.
Chinese capital outflows slowed more than expected in January 2017 due largely to stronger capital controls, especially those related to households’ foreign exchange conversion. In addition, state-owned enterprises and exporters have reportedly been asked to convert foreign exchange proceeds to renminbi (RMB) in case they are needed to stabilize the currency. Banks and corporates are also being encouraged to issue more foreign currency bonds in the offshore market with some proceeds to be remitted onshore, a shift from past practices. In our view, these measures could be very powerful, since from 2014, corporates have been the major source of foreign exchange outflows. In the offshore currency (CNH) market, reduced liquidity and spikes in funding costs have made short selling of CNH positions vulnerable, especially amid rising market volatility. The above factors have helped the RMB trade between 6.7-6.99, mainly on the stronger side of this range.1
We expect this trend to continue in the near term, unless new Trump administration policies lead to a much stronger U.S. dollar move.
The value of the yen is likely to be driven more by external than domestic developments in the near term, with a particular focus on the actions of U.S. President Donald Trump as his administration gets underway. The yen should act as a good hedge for short U.S. duration/long U.S. dollar positions if Trump’s policies do not meet market expectations – U.S. yields would likely decline in that case. A long yen position could help offset losses in the short duration position.
Sterling continues to be undervalued, in our view, however, we do not see any obvious catalyst for a meaningful correction in the near term. The UK government will likely want to ensure that its economy remains strong as it enters negotiations over its EU exit, and a weaker sterling could also enhance its bargaining position; if the UK rejects an EU trade agreement meaning higher World Trade Organization (WTO) tariffs would apply by default, higher WTO tariffs could be offset by a weaker sterling.
Increased commodities prices plus recent signs of higher than expected inflation have put upward pressure on the Australian dollar recently. With the Australian policy rate remaining at all-time lows, and the economy appearing to be in good shape, we do not expect the RBA to lower rates further in the near future. With the RBA on hold, we expect the Australian dollar to be relatively stable at current levels.
With contributions from James Ong, Senior Macro Strategist, Brian Schneider, Head of North American Rates, Sean Connery, Portfolio Manager, Scott Case, Portfolio Manager and Alex Schwiersch, Portfolio Manager.