Currency crosscurrents in play

The factors responsible for the US dollar’s depreciation over the past year have started to reverse. While the pressures on the Eurozone and Japan to bring forward policy normalisation have rec...
Philip Wee10 Apr 2018
Photo credit: AFP Photo

The factors responsible for the US dollar’s depreciation over the past year have started to reverse. The US Treasury (UST) 10-year yield has been rising toward 3% since the start of 2018, well above the 2.60% the same time last year when the US Dollar Index (DXY) was above 100. Unlike 2017, we now have a Federal Reserve that is looking for US inflation to rise towards its 2% target this year. Corporate tax cuts and a new Fed Chairman in favour of expanding bank credit to families/businesses should be net positive for growth. With the DXY at lows around 90 and “America open for business”, US President Donald Trump has stopped complaining about a strong greenback. Hence, we have upgraded our US growth outlook and brought forward our Fed hikes call by a quarter to March and June.

The pressures on the Eurozone and Japan to bring forward monetary policy normalisation have receded after the market volatility in early-February. The Bank of Japan has pushed back against “stealth tapering” allegations and reaffirmed its commitment to its quantitative and qualitative easing and yield curve control policies. Unless the euro surprises with more appreciation, say to 1.30, the European Central Bank (ECB) will end its asset purchase programme in September to December.

For now, we assume that the euro has graduated into a higher “pre-normalisation range” of 1.15-1.25 from its previous 1.05-1.15 band set after the ECB launched quantitative easing in 2015. As the focus on normalisation turns from the ECB to the Fed, the euro should start to retreat from the ceiling of its new range. Don’t expect a repeat of last year’s political/economic surprises. Eurozone growth has started to moderate from its six-year peak of 2.8% y/y in 3Q17. German Chancellor Angela Merkel has finally formed a grand coalition but she and her allies have been weakened by the process. An increase in Euroscepticism was evident at the Italian elections on 4 March, but this was more about voters rejecting establishment parties than about exiting the EU. The yen should also weaken back into its 110-115 range as rate differentials reassert themselves again, on the precondition that global equities do not falter and result in a flight to safety into the yen.

The next Fed hike in March has scope to hurt the Australian dollar, the Korean won and the Thai baht, the currencies with the same policy rate as the US. Despite their more optimistic growth outlook, inflation in these three countries are subdued below their official targets. More importantly, the Reserve Bank of Australia does not see a need to follow other central banks in hiking rates. The Thai finance ministry has upgraded its growth outlook on the assumption for no rate hikes this year. The Bank of Korea is not in a hurry to follow through on its last rate hike in November.

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