By Iain Cunningham, co-Portfolio Manager, Ninety One Global Macro Allocation Fund
US dollar strength has dominated currency markets this quarter, a situation that could remain.
The outlook for major currencies has become increasingly uncertain. Material policy divergence has been present over the past 11 months, with the Federal Reserve moving into an aggressive hiking cycle, while the PBoC have been easing and major European Central Banks have fallen somewhere in the middle. This divergence has resulted in a strong appreciation in the US dollar. While these dynamics are expected to persist in the short term our belief is that this policy divergence is well priced by exchange rate markets and we are now inclined to believe that the US economy will likely be decelerating heading into 2023, while the Chinese economy should be accelerating. This dynamic reduces the prospect for further notable US dollar strength relative to Asian currencies.
One area we see policy divergence evolving over the next 12 months is in the $ Bloc (Canadian dollar, Australian dollar & New Zealand dollar) currencies due to structural imbalances within their underlying economies. While US households experienced a period of deleveraging post the global financial crisis, these economies have continued to see debt piles build and housing markets become ever more inflated. This creates headwinds to growth and inflation and constrains the ability of domestic central banks to maintain high interest rates, ultimately creating a divergence with the US, where imbalances are less extended. Hence, these currencies should underperform the US dollar.
Within the Euro Bloc, Sweden faces similar structural imbalances within its economy that should act as headwinds to growth and inflation. Household debt piles have continued to grow within the Nordic economy, as consumers became increasingly leveraged to the housing market due to a persistent environment of low interest rates and under supply of housing. This creates challenges for the Riksbank as they attempt to tighten policy in order to tame inflation and we have already seen the impact of interest rate hikes be felt in the domestic housing market with rapid falls in prices. Ultimately, these dynamics constrain the ability of the central bank to maintain high interest rates. Hence, we expect the Swedish Krona to underperform other European currencies such as the Swiss Franc where the Swiss National Bank are increasingly becoming more hawkish.
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