investment insights
The year of the renminbi
Key highlights
- While the year 2020, notably the second half, was a period of USD depreciating to its fundamentals, 2021 is shaping up to be the year of the renminbi.
- We forecast some extension of the dollar depreciation in H1, and our macro team pencils in a 50% chance of some reduction in Section 301 tariffs on China from the incoming Biden administration.
- Together with a recovery in global trade volumes and still-accommodative policies from the Fed, ECB, and PBoC, we believe euro-dollar can reach 1.27 and dollar-yuan could target 6.15 this year.
- The Japanese yen remains amongst our top G10 picks, and we think dollar-yen will decline below 100 even in a relatively positive global risk environment.
- On the other hand, the Swiss franc should lag behind the euro, and we see euro/Swiss franc moving up modestly to 1.10.
- The weak dollar will support sterling, but gains will be moderate due to Brexit.
- Upward emerging market GDP revisions for Q1, a stronger tone in energy prices, and a higher euro-dollar point to GBIEMFX gains over Q1. We prefer to remain selective in emerging FX.
- This month, we upgrade our view on the yuan, Israeli shekel, and Turkish lira, but downgrade our view on the Mexican peso.
A number of developments in the last month or so argue for a slightly deeper US dollar depreciation than we had initially expected. First, the pace of the USD decline has accelerated, suggesting that momentum trades are taking over; historically, this has led to more rapid price depreciation, despite some near-term volatility due to extreme positioning. We now conclude that the dollar cyclical trough will occur around Q2/Q3 21 (instead of end-2021 previously). Second, it appears that the rebound in global trade is sharper, hinting at additional gains for pro-cyclical and trade-exposed currencies.
At the same time, the recent increase in long US nominal yields fuelled by expectations of additional fiscal stimulus should not be seen as dollar-supportive. This is because the increase is likely to be accompanied by rises in US inflation expectations, which will then leave US real yields at familiar depressed levels. That said, the revisions to our forecasts have been relatively modest as we are mindful that valuations are less compelling than half a year ago.
More specifically, we now see EURUSD peaking at 1.27 at Q2 21 and adopting a relatively flat profile afterwards. Moreover, we maintain an upward bias for EURCHF given solid risk appetite and an acceleration in Swiss portfolio flows. However, the latter appear so far insufficient to recycle a large part of Switzerland's current account surplus. Hence, we have trimmed our forecasts, anticipating EURCHF at 1.10 by Q2 21.
We have not changed the level of our forecasts for GBPUSD, as we still expect headwinds due to Brexit and the economic impact of the third national lockdown to weigh on the currency. We now see GBPUSD peaking at 1.38 in Q2 21. Turning to the JPY, we think the slightly deeper broad dollar decline we project is likely to drag USDJPY below 100, especially in light of an ongoing and sizeable overvaluation.
Upward EM GDP revisions for Q1 and a stronger tone in energy prices suggest EMFX can still see further gains in the coming months, though we prefer to maintain a selective approach. This month, we further upgrade our view on the renminbi, forecasting a trough of 6.15 this year as we assume even odds of some reduction in Section 301 tariffs. In that respect, we have increased our CNY overweight in our portfolios.
Main risks to our views: The main upside risk to our forecasts comes from a stronger recovery in global trade, which will send the USD into an even steeper decline and support bigger and broader rallies in the G10 and emerging markets. On the downside, we see the following risks: First, the Federal Reserve (Fed) turning less dovish and so triggering a market reaction like 2013's "taper tantrum". Second, a delay in the distribution of Covid-19 vaccines would increase the risk of new restrictions and economic disruption. Third, a premature withdrawal of fiscal support.
In the Nordics, we maintain our preference for the NOK over SEK, while in the core commodity FX bloc we now see CAD outperforming. That said, the pace of appreciation of all cyclically sensitive G10 currencies vs the USD is set to slow.
The US dollar-Chinese yuan cross (USDCNY) has now breached the 6.90 – 7.15 range we assumed. This mostly reflects a weaker USD and fast improving Chinese balance-of-payments dynamics, but very recently, markets have begun pricing in a Biden presidency and lower tariffs. We revise down our USDCNY forecast to 6.75 and 6.68 on a 3- and 12-month view. A reduction in tariffs under a Biden presidency would be CNY-bullish, and should see CNH recover lost ground against other currencies, including the EUR.
In emerging markets (EM), we remain structurally neutral on the overall GBIEMFX index, but our forecasts now show a modest spot return of 0.40% on a 12M view, with the bulk of the gains coming in the next six months (a successful Coronavirus vaccine would help accelerate this process).
Country selection remains crucial, and we continue to prefer currencies with low debt, high exposure to Chinese infrastructure spending (KRW and CLP), EURUSD upside (PLN and CZK), and the tech sector (TWD). In Asian FX, we have upgraded INR to "modestly bullish" and remain "modestly bullish" on the CNY (but would upgrade to bullish if there were more evidence that a Biden Presidency comes alongside a reduction in tariffs).
Main risks to our view: First, a second strong Covid-19 wave that again disrupts economic activity and increases demand for dollars. Second, the euro appreciation may have become an unwelcome development for the ECB. Although the room for policy action is far more limited than in the past, any verbal intervention is likely to weigh somewhat on the common currency and support the dollar. Third, a re-escalation of China-US trade frictions could halt the recovery in global trade and would underpin the greenback.
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