investment insights
Low conviction for now
Key highlights
- Ongoing growth concerns, especially in China, are likely to keep investors cautious for the near term
- Our conviction is now lower for the short term and we see FX trading in narrow ranges until activity indicators stabilise
- When this happens (likely in Q4 21) the dollar is likely to experience some weakness again
- In emerging markets, the narrowing EM-US growth differential and levelling off in commodity prices pose challenges
- We continue to favour the renminbi because of positive structural factors, but the cyclical elements have turned somewhat negative. As a result, we have raised our USDRMB forecast to 6.45 for year-end and 6.35 by Q3 22.
The next few months are likely to see a continuation of recent narrow ranges in FX, due to multiple crosscurrents.
On one hand, global activity indicators have slowed, most evidently in China1 as the removal of 2020 stimulus and emergence of the Delta variant are pressuring credit impulse and activity, while the ongoing regulatory crackdown2 is weighing on sentiment. While this slowdown should not be seen as heralding a more severe downturn, it is certainly enough to turn investors more cautious for now. Effectively, this places us in an environment of low visibility, where the dollar may be slightly favoured. On the other hand, and despite some softening in euro area Purchasing Managers Indices (PMIs), the rotation of growth towards Europe is taking place, which should be supportive for the euro. On balance, this leaves us with low conviction for the short term, reflected in our view of EURUSD range trading around the 1.18 level in the near term.
That said, several factors could cause fluctuations in the currency market in the coming months. Inflation remains high and the debate about whether or not it is transitory continues. This has even led the ECB to make baby hawkish steps3 that may increase market uncertainty. Recent disappointing US payroll gains add to confusion and could lead investors to price out some Fed rate hikes for the next two years.
Overall, we have adopted a cautious approach, and expect a relatively directionless FX market in the near term. Farther out, we believe that global activity will eventually stabilise and alleviate recent growth concerns. This should prove USD-negative. All of this is reflected in our portfolios, where we have reduced our FX risk, maintaining only a small renminbi (RMB) long exposure due to structural factors and positive carry.
We are neutral on EURUSD in the short term but expect some modest upside towards the end of the year and into 2022, as long as our assumption of growth stabilisation proves correct. The rotation of growth towards Europe should also eventually push EURCHF higher, although the increase in uncertainty is likely to restrain the move, especially over the next month or so. We maintain our neutral view on sterling and the yen as we think cyclical factors and risks are quite adequately priced in.
Nordic currencies should trade in tandem with risk appetite, although the NOK – which was heavily penalised during the summer months – could be subject to upside given the start of the hiking cycle by the Norges Bank. We hold similar views for the core commodity FX bloc.
For emerging market currencies, the narrowing of the EM-US growth differential and levelling off in commodity prices is likely to mark a challenging period.
We continue to favour the RMB because of positive structural factors, but the cyclical elements have turned somewhat negative. As a result, we have raised our USDRMB forecast to 6.45 for the end of this year and to 6.35 by Q3 22.
Main risks to our view: Our baseline scenario assumes near-term range trading, followed by some dollar depreciation as growth dynamics stabilise. The main upside risks to our forecasts include: first, a faster stabilisation in global activity; and, second, the Federal Reserve (Fed) turning more dovish if labour market gains disappoint again. On the downside, we see the following risks: first, renewed virus-related restrictions and lockdowns. Second, the Fed gradually turning more hawkish if inflation proves less transitory. Third, a premature withdrawal of global fiscal support.
1 https://www.bloomberg.com/news/articles/2021-08-31/china-s-economic-activity-weakens-in-august-amid-delta-outbreak
2 https://www.cnbc.com/2021/08/30/china-tech-crackdown-experts-warn-on-the-risks-ahead-for-stocks.html
3 https://www.reuters.com/business/finance/ecb-may-dial-back-support-wont-take-it-away-just-yet-2021-09-08/
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