I think it is safe to say that the first half of 2020 has been the strangest six months that any of us have ever had; lockdowns, closures, lives lived online and frantic attempts to keep some semblance of normality.
Similarly, currency markets have had one of the strangest halves in living memory with the first wave of Covid-19 infections and deaths as well as the wider response from both economic and political policymakers dominating movements.
While the second half of the year will still be affected by Covid-19, as will many years to come, there are also other issues that businesses who import or export, or who are part of supply chains that span multiple countries, will need to be aware of.
So, here are our expectations for all the major currencies through the second half of 2020.
GBP
The pound is strongly correlated with equity markets and wider measures of risk on the basis that it holds a lot of similarities with emerging market currencies given its dual deficits – both on trade and government financing – and its dependence on foreign investment to balance the books. In the good times, this financing is easier and therefore the pound becomes more attractive.
As we enter the second half of the year, the trade balance is positive whilst the primary income measure is severely negative given the issue around spending and tax income. This would typically lead to sterling weakness.
We had also hoped that the government would use Coronavirus and the disruption it caused both socially and economically to allow for a little more time to put together the best possible Brexit. That isn’t going to be the case. The UK will leave the EU at the end of the year; the only question that remains is in what trading state?
Talks will continue through July and August between the UK and EU but if we do not see signs of something approaching a trade arrangement by September, then we would expect the pound to come under pressure from fears of a no-deal exit with clarification coming in October.
As we have noted in the past, it makes sense to watch out for sterling on Mondays and Fridays moving forward. Negotiations between the UK and EU end on Fridays so there will always be headline risk from how the previous week’s talks have evolved. Likewise, politicians tend to use the Sunday papers to go on manoeuvres to throw up test balloons on policy or opposition to decisions and therefore Monday trade can be volatile.
We have to remember that currency markets are all about relativity and we expect that the recovery in the UK will lag that elsewhere – both given the UK government’s response to Covid-19 and the wider uncertainties over Brexit – and that should keep sterling under pressure.
We think this will manifest via an unwillingness of the Bank of England to raise interest rates, higher inflation, slower returns from unemployment and lower productivity.
EUR
It’s nice to not have to worry about a break-up in Europe for once. The actions of the ECB have managed to contain the risk in European markets that pushed EUR/USD below 1.09 and has marked previous periods of market crisis.
Given this precedent, we now can largely put redenomination risk to bed as a major influence on the EUR although we will continue to keep an eye on bond yields.
With this, we think that it’s time for the euro to push higher. The economic data coming out of the Eurozone at the moment is pretty weak and should turn higher in the coming months that will allow the EUR to push above the 1.14 level against USD and 0.91 against GBP.
For this to be more than a momentary move however, we need to see the global investment atmosphere remain positive or we risk seeing the euro lose out to haven assets.
We also see EUR strength coming from excessive USD liquidity. Quantitative easing in the US is running at unlimited levels and alongside a trade and budget deficit, could lead to reserve diversification as well as increased economic prospects for China (a closer trade partner for Europe than the US) and hopes that the EU manages to sign off its budget and recovery plans in the coming few months.
USD
We think it’s time for the USD to loosen its grip on the world of currency. This is not us calling for the end of the dollar as the global reserve of choice and the currency of the world’s liquidity but simply a belief that there will be currencies out there in the coming 6-12 months that should be able to extract gains against the greenback.
Most of these expectations are based on the belief that markets will continue to price in a recovery of the global economy and that the economic data bears that out. There’s a huge amount of conditionality around this of course – nobody knows how widespread the virus will remain and its wider effects on sentiment and spending.
Commodity currencies are the first group of currencies that we expect to run higher against the USD in the coming six months. This is mainly based on the expectation that with a wider improvement in economic prospects, commodities will be in higher demand for industrial purposes and therefore we anticipate a slight increase in inflation in those commodity exporting countries.
Similarly, emerging market countries whose economies are driven by exports and who are typically vehicles for investment given attractive yields on local government debt, should also be able to put in some gains against the USD.
Currencies that may lose ground against the USD in this scenario are pretty thin on the ground but are likely to be those ones that mirror the USD by strengthening when markets become increasingly risky on a haven bid – these would include the JPY and CHF.
The big hurdle for the US dollar and wider markets in the latter half of the year is the US election in November between President Trump and the former Vice President, Joe Biden.
We highlight four issues within the election as crucial for currency
• Fears over a second peak of Covid-19 infections
• US/China trade tensions
• Black Lives Matter protests
• Control of the chambers and wider governance
With Covid-19, it seems obvious that healthcare will be one of the most prominent political footballs between the campaigns and while Democrats may be able to extract political points in blaming the Trump administration for the US’s response to the pandemic, whether that will shift voters’ minds towards supporting a more universal form of healthcare remains uncertain.
From an operational point of view this could see people shift from voting in person to casting their vote via mail. This will also increase the rhetoric from the Trump administration that the vote is rigged; something we expect him to rely on should he lose.
Trade tensions between the US and China have continued to bubble away while Coronavirus has been making headlines but will likely move front and centre as the campaigns get into full swing. Being tough on China is not a singularly Trumpian policy and Biden cannot afford to look weak or soft on Beijing in front of an electorate that has been fed a diet of anti-China news and policies over the past 4 years.
We expect that President Trump will tighten the screws on China in the lead-up to the election to reinforce the belief that he is tough on America’s trade ‘enemies’. We doubt that China will react until after the election; they will likely wait to see just who they will be squaring up to for the next four years before retaliating. This should keep the Chinese yuan strong against the USD into the end of the year.
Black Lives Matter protests are set to be a centrepiece of the US elections and should begin a conversation on wider civil liberties but may fail to have a great effect on voting patterns. Research has shown that similar civil rights protests in the past have increased the voting activity of educated white voters more than minority voters. The theory stands that minority voters do not believe that voting will change anything given it hasn’t in the past.
Of course, any President is only as powerful as the support he is able to count upon in Congress. Currently the Senate is held by the Republicans with the House held by the Democrats which has led to a stymying of the Trump agenda since the midterm elections in 2018. We have no doubts that the House will remain held by the Democrats but for Biden to have the full support of both chambers of Congress he will need to see 7 Democrats win previously held Republican seats in the 23 Senate seats that are up for grab this year – a tough ask.
As for the dollar reaction, we expect a Trump win to remain dollar positive with a Biden win likely to weaken the USD especially if the Democrats manage to win in a landslide and take the Senate too.
What about the others?
Sterling, the euro and the US dollar aren’t the only currencies out there so here is a quick look at the rest of the G10.
JPY
The Bank of Japan’s policy of yield curve control measures – a stimulus plan that keeps Japanese government bond yields artificially low – should cap yields and keep the JPY weak moving forward in a world wherein investors are searching for yield and prepared to take on more risk
AUD
Despite the recent news of some regional lockdowns, wider second wave expectations are low and despite the currency’s recent strong run higher market positioning remains short so we could easily see this strength continue towards 0.72 in AUD/USD terms.
NZD
Whilst the Kiwi dollar and wider New Zealand economy mirrors a lot of the reasons for AUD strength, we feel that the Reserve Bank of New Zealand will continue to use its playbook of currency weakening to stimulate exports in a bid to diversify away from China.
CAD
March’s movements in oil markets have largely been forgotten about but both crude and WTI measures have been showing strength and businesses within Canadian provinces are opening well. This has been borne out in the data and the Bank of Canada says it is seeing data consistent with its most optimistic scenario of a recovery and we think the CAD could therefore continue to outperform.
SEK
The possibility of further quantitative easing in Sweden cannot be ruled out and therefore we expect the SEK to underperform moving forward.
NOK
On the other side of that coin is the Norwegian krone which we believe could be one of the best performers in the second half of the year given the government’s need for NOK and its ability to sell assets from its sovereign wealth fund.
CHF
Given our belief that the euro should outperform on a lessening of European breakdown risks, it should allow for the CHF to weaken away from its overbought levels that it operates in currently.
Conclusion
Our expectations are largely couched in the belief that the global economic recovery will continue albeit with periods wherein uncertainty waxes and wanes given the chances of second or third peaks of the virus. In that circumstance, alongside a global tide of stimulus, we expect currencies allied to risk – NOK, GBP, AUD and other commodity currencies to outperform.
Summary of wider expectations:
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