investment insights
A change in market narrative: from inflation fear to growth scare
Key highlights
- A change in market narrative towards a more defensive stance owing to growth concerns has allowed the dollar to hold onto its post-Federal Open Market Committee (FOMC) gains.
- However, we still believe that growth momentum in Europe will be sustained and that this should ultimately prove EUR-positive
- If so, EURCHF weakness should revert in the coming months. At the same time, we maintain a neutral stance towards GBP and JPY for now
- We had said H2 would be more challenging for EMFX, and loss of momentum in commodity prices adds to this view
- The RMB remains our top pick, but we have slightly revised up our year-end target for USDRMB to 6.30 (from 6.22 previously) as we pare the odds of material progress on the US-China trade dialogue in 2021.
Following the FOMC meeting in mid-June that saw the dollar rise across the board, market sentiment appears to have changed markedly. The confluence of slowdown signs in China, rising Covid-19 cases due to the Delta variant, and OPEC1+’s initial failure to agree on a production increase has shifted the market narrative from “inflation fear” to “growth scare”.
Defensive and growth stocks have started outperforming respectively cyclical and value equities, while emerging market spreads have widened. Nominal and real yields have declined, especially at longer tenors, and commodity prices have struggled. This defensive turn in the market has helped the dollar to hold onto its post-FOMC gains.
Although growth momentum has lost some steam (most evident in the US and China), we think the market is mispricing the rotation of growth towards Europe. Survey data suggests still very robust activity in the region despite ongoing Covid-related restrictions. In our view, the vaccination rollout will allow restrictions to be lifted further, which should in turn sustain the economic momentum.
As a result, we maintain our constructive stance on EURUSD and EURCHF.
On the other hand, we remain neutral on sterling and the yen. In both cases, we see a lack of catalysts to spur sharp moves in either direction.
Growth concerns are likely to maintain some pressure on the Nordic and commodity currencies due to their high beta-to-risk nature. However, further out, we still expect some reversal as growth concerns dissipate and certain central banks either tighten outright or begin to send tightening signals. For EM currencies, we are likely entering a more challenging period as growth slows versus the US in H2 and commodity prices lose momentum. We make no changes to our relative preferences.
We continue to favour the RMB but have raised our year-end forecast to 6.30 (from 6.22) as we lower expectations of any significant progress on the US-China trade dialogue in 2021. That said, a still-solid balance of payments – driven by several contributing factors – should offer support.
Main risks to our view: The main upside risk to our forecasts comes from a stronger recovery in global trade that could support bigger and broader rallies in the G10 and emerging markets. On the downside, we see the following risks: first, renewed virus-related restrictions and lockdowns. Second, the Federal Reserve gradually turning more hawkish. Third, a premature withdrawal of global fiscal support.
1 Organization of the Petroleum Exporting Countries (OPEC)
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