Global Currencies 3Q19: US dollar underpinned

The US economy is sound but not immune to global risks, especially those involving US-China trade tensions
Chief Investment Office23 Jul 2019
Photo credit: AFP Photo

The relative strength of the US dollar has been shaken but not shattered by Fed cut expectations. The Federal Reserve believes the US economy is sound but not immune to global risks, especially those pertaining to escalating US-China trade tensions, a disorderly Brexit, and a fragile Eurozone economy. In pursuing policies that escalate global trade tensions, US President Donald Trump does not favour a stronger US dollar and prefers lower interest rates. Ironically, this has resulted in the US having the best economic growth and highest interest rates in DM. The relative strength of the US was best reflected by the UST 10-year yield holding above its 2% inflation target, and its European counterpart pushing new lifetime lows below 0%. Until these trends reverse, the greenback will be underpinned by the US’s relatively strong economy.

The euro is not out of the woods and a depreciation below 1.10 cannot be discounted. Europe’s 10-year bond yield has not only turned negative but has also fallen below its Japanese counterpart, a stark warning that the green shoots in the Eurozone economy could wither. The ECB staff forecast for 2019 growth has stabilised at 1.2% in June but is still well below the 1.7% projected at the start of the year. The ECB governing council needs to keep a dovish forward guidance and monitor downside risks from escalating trade tensions, a slowing Chinese economy, increased odds for a disorderly Brexit, and a potential EU-US tariff war ahead.

The British pound can revisit its post-referendum low around 1.20. Theresa May stepped down as Conservative Party leader on 7 June but remains as caretaker Prime Minister until a new leader is elected. It is doubtful that the next premier can unite the party and parliament in delivering Brexit with or without a deal. Brussels has no intention to renegotiate the thrice rejected withdrawal agreement. Withdrawing Article 50 or a second referendum are no longer palatable to the Tories after the strong showing by the Brexit Party at the European Parliamentary elections. The legal default position remains for the UK to exit the EU without a deal on 31 October. The BOE fears that corporate investment plans would be held back by another Brexit delay or abandoned on a disorderly Brexit.

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