Main asset classes USD set to crest

USD set to crest

The USD should hold up initially, but the EUR is likely to gain in the second half as a Eurozone recovery takes hold. The CNY may depreciate slightly more vs. the USD on domestic weakness. The GBP should gain strongly on the back of a Brexit resolution.

Major currencies: USD carry to lose its clout 

In 2019, the USD continued to gain against most developed market (DM) currencies. If global growth and trade stabilize, as we expect, the cyclically sensitive EUR should gain ground. Yet if the geopolitical situation worsens or global growth disappoints, the USD would stay supported while the JPY and CHF would likely be the biggest winners. 

USD: Going into 2020, the USD should remain supported as it retains a growth as well as interest rate advantage, or “carry,” over most other G10 currencies. But these advantages are likely to weaken in the course of the year. Moreover, the focus of market participants may begin to shift to the overvaluation of the USD, encouraging outflows from USD assets. 

EUR: After disappointing in 2019, the Eurozone is expected to show moderate growth in 2020, in part supported by added fiscal stimulus and diminishing Brexit uncertainty. This should support the EUR. Longer-term factors, especially the region’s growing current account surplus, are also supportive. Renewed worries over Italy’s political and fiscal stability pose a (low probability) risk. 

JPY: Although global risk aversion should abate and limit the upside potential of the JPY, we think the JPY’s undervaluation against the USD should support the currency. The fact that the Bank of Japan is constrained regarding interest rate cuts is also supportive. 

GBP: In 2019, the GBP suffered bouts of weakness amid continued Brexit uncertainty. In 2020, we think the GBP has the greatest appreciation potential given its significant undervaluation and the increasing likelihood of a Brexit deal being voted through and implemented over the coming months. In that event, the Bank of England would also be more likely to tighten policy and further support the GBP. 

CHF: The CHF is overvalued against the EUR. If the Eurozone economy picks up, the CHF could well lose some ground against the EUR. If the global political and economic outlook were to worsen, the Swiss National Bank would likely continue to intervene to limit CHF appreciation.

Spread in percentage points and dollar index (RHS)

Interest rate support for USD waning

Spread in percentage points and dollar index (RHS)

Stabilizing growth

Most emerging market (EM) currencies fared better in 2019 than the year before. With the US Federal Reserve easing policy, their carry provided support. Beyond this general factor, performance differed considerably between regions and countries. In Asia, China allowed the CNY to weaken in order to offset some of the US tariff burden, which put pressure on other currencies in the region. Low-yielding currencies in the Europe, Middle East and Africa region were the largest underperformers.

Looking ahead, EM currencies enter the year with a lower carry advantage; real interest rates dropped considerably in 2019 on the back of monetary policy easing. Conversely, valuations have generally become more attractive. Moreover, growth should pick up in many EM in response to looser financial conditions.

CNY: The currency underperformed most Asian peers in 2019. Any de-escalation in the trade war would alleviate pressure, in particular now that the currency is closer to fair value. However, with China’s growth likely to continue to slow and its current account surplus much reduced, we do not see any longer-lasting upside.

KRW: The KRW lost ground in the first months of 2019 due to the economy’s close integration into Chinese-based supply chains but it recovered thereafter. It should continue to recover if the trade war abates and sentiment on the tech sector continues to improve, not least because it is now clearly undervalued.

INR: Possible reforms in the areas of tax, labor and investment laws are likely to attract foreign investment inflows over time, supporting the currency. Valuation is fair but carry is eroding.

MXN: The MXN is a “trade war winner” with Mexico’s exports gaining on the back of China’s setbacks. Meanwhile, political pressure lifted after the USA, Canada and Mexico signed a new trade treaty. With growth expected to pick up moderately and the central bank taking a cautious stance, the MXN’s carry should erode only gradually. Valuation is supportive.

BRL: Valuation has improved and growth seems to be stabilizing, with economic surprise indices at the highest levels in over a year. With pension reform complete, attention is likely to shift to tax reform. We do not expect the central bank to cut the benchmark Selic rate more than the market currently anticipates. The currency should hold up.

RUB: A strong current account surplus and low debt levels are still supportive. However, after appreciating strongly in 2019, the RUB is no longer attractive from a valuation perspective.

TRY: Fundamental valuation, a still high carry and an improving economy should offset political uncertainty. However, volatility is likely to remain high.

ZAR: South Africa continues to lag as economic imbalances keep building and the outlook for structural reforms remains bleak. The currency is likely to remain under pressure.