Whither major currencies?
The US dollar looks vulnerable after the covid-19 crisis as it has lost its high-yielding status and is particularly overvalued. We continue to expect the US dollar to depreciate somewhat in the months ahead because growth and interest rate differentials, the two key drivers that have supported it in recent years, have deteriorated significantly.
By contrast, prospects for the euro and the Chinese renminbi, two alternatives to the US dollar, have improved. In particular, we have adjusted higher our projections for the EUR/USD rate. The three-month projection now stands at USD1.15, the six-month projection at USD1.18 and the 12-month projection at USD1.20.
The Chinese renminbi proved particularly stable during the market turmoil caused by this year’s covid-19 outbreak. Furthermore, rate differentials are moving increasingly in favour of the renminbi relative to the US dollar. And while we expect tensions between US and China to remain elevated, a potential change in the US administration at the end of the year could lead to some slight improvements.
Massive liquidity injections into financial systems by major central banks and the global economic recovery should provide some support to cyclical developed-market currencies. Among major cyclical currencies, our preference goes to the Australian dollar and the Norwegian krone.
We remain cautious on sterling as the combination of a slow economic recovery, Brexit risks, very negative long-term real rates and a relatively dovish central bank should weigh on the currency.
We do not have a particularly negative view on defensive currencies like the Swiss franc and Japanese yen, although we acknowledge that the global environment may prove less supportive than at the height of the market turmoil caused by the coronavirus outbreak.
We believe the yen is poised to appreciate against the US dollar given highly supportive long-term real rates (historically, a key driver for the yen) and our expectation that Japanese investors will buy less foreign bonds. We are somewhat less optimistic about the Swiss franc, notably because the prospect of deeper European integration could increase net capital flows out of Switzerland. Furthermore, as it showed during the first half of this year, the Swiss National Bank stands ready to curb any unwanted appreciation of the franc.