Investment Strategy: First Quarter 2020 – Currencies
- Currencies are an asset class everyone expects to be volatile and 2019 was a year of great political uncertainty with the tariff wars and Brexit and rapidly changing market views on growth and monetary policy. Yet despite all this, the foreign exchange markets were surprisingly benign, presumably on the basis that no-one had a scooby what was going on. I read somewhere that the US dollar has been its least volatile for 40 years, which may well be an example of someone manipulating the figures to give the answer they want but it has felt pretty quiet on the FX front.
- What volatility there has been has centred, not surprisingly, on sterling. The Brexit despair led to a weak pound throughout the spring and summer months but the Tory election victory led to a euphoric bounce with the pound charging upward in the quarter, making it, surprisingly, the strongest of the major currencies last year, gaining 3% against the yen, 4% against the dollar and 7% against the euro. As Michael Caine would say, ‘not a lot of people know that’. The problem for sterling though, is that Brexit is not done at all, especially given Boris’s hard line of no extension to the transition period, so a trade ‘no-deal’ is still an option and sterling will hate that.
- There is an increasing sense that after years of strength the US dollar may begin a weaker trend. Higher interest rates and a more robust economy have all attracted money into the greenback over the last few years with the dollar a beneficiary of the ‘carry trade’ whereby investors/speculators borrow in a low-yielding currency to buy a higher-yielding one but these attractions are set to wane. Growth looks to be more synchronised this year, the US Fed is easing and US bond yields have fallen more than in other developed markets. There is also something of a deglobalisation, de-dollarisation trend starting with the dollar losing some lustre as the global reserve currency with China, for example, doing a lot more business in euros. A weaker dollar is likely to be beneficial for the global economy and financial markets and it means cheaper financing costs for companies in emerging markets and helps boost the earnings of the big US exporters. In shorthand, a weak dollar tends to be ‘risk-on’ and vice-versa.
Summary: There is always a huge ‘unpredictability’ caveat in forecasting currencies but sterling should continue to remain firm as long as Brexit negotiations look like reaching some sort of amicable resolution (a big if!) whilst the mighty dollar could weaken this year.
