perspectives d’investissement
US-China tensions make a comeback
Key highlights
- We have lowered our euro-dollar forecasts to reflect on the recent messy constitutional challenges the euro area is facing. However, some progress on the coordinated Covid-19 fiscal response (recovery fund) poses upside risks to our new forecasts
- EURCHF is likely to trade close to the 1.05 level, as demand for Swiss francs will likely be offset by SNB intervention
- Although we maintain our sterling forecasts for now, downside risks to the currency are rapidly increasing
- As things stand, the yen remains our favoured play against the dollar across the main G10 currencies, while gold should be in any balanced portfolio to counter the materialisation of an adverse scenario
- In EM, we reiterate our view for Asia to outperform other regions. However, we have increased our USDCNY forecasts to reflect a higher risk premium due to the comeback of US-China tensions. The Brazilian real, South African rand and Turkish lira will remain at the bottom of the performance pile.
There have been four important developments in global markets relevant for the FX world, which have been working in opposite directions.
On the positive side, the Covid-19 infection curve has plateaued allowing the gradual re-opening of most main economies, which should pave the way to a growth recovery in H2 2020. In addition, the EU looks closer to an agreement on a recovery fund, though this is by no means certain yet. On the negative side, US-China frictions have come to the forefront again with the US administration accusing China of mishandling the virus outbreak and threatening with retaliatory measures. Moreover, the German court ruling on the ECB’s PSPP has created a messy constitutional challenge in the euro area that is likely to weigh on investors’ sentiment and add a risk premium to the euro.
Our fundamental case for USD weakness in the second half of the year remains in place, however we now see EURUSD lagging, with our forecast for year-end trimmed to 1.11. The increase in Eurozone-related risks also implies a lower trajectory for EURCHF than the one we had pencilled in before: we now see the pair stable at 1.05 as ongoing demand for francs will likely be offset by continued SNB intervention.
Turning to sterling, we maintain our base case of a deal being reaching with the EU at the end of the year, which should be fundamentally supportive. However, we acknowledge that there is lack of progress and the limited time available suggests risks are to the downside.
Within the main G10 currencies, our preference remains for the Japanese yen. It screens as deeply undervalued on multiple metrics while it continues to exhibit global safe haven properties. The yen and gold remain two of the best hedges against a resurgence of risk aversion.
Turning to emerging markets, since the sharp decline in energy prices in March, the GBIEM FX index has largely been range bound despite the modest recovery in energy prices. However, there has been a big divergence in terms of performance: currencies of North Asia and Central Eastern Europe as well as the CLP in LatAm have held in quite well; supported by stronger external balances, lower starting levels for government debt and their status as net-energy importers. On the other hand, higher-yielding, commodity-sensitive currencies have underperformed.
Within this latter group, currencies having lower debt levels and relatively hawkish central banks (IDR and RUB) have recovered nicely while both the Mexican and Colombian pesos - having more manageable debt burdens - have also stabilised.
However, currencies like the Turkish lira and Brazilian real have been the clear underperformers given weak external balances (Turkey) and elevated debt levels and growing fiscal risks (Brazil). We expect these divergences to become more pronounced and have further raised our forecasts for USDBRL to reflect additional risks related to the unstable political situation.
Meanwhile, while the Chinese yuan has been amongst the most stable EM currencies, the recent rise in US-China tensions has been a noteworthy and unwelcome development. We have adjusted our USDCNY forecasts, now expecting 7.08 and 7.03 for Q2 and Q4, respectively. Even while our base case scenario is for large new tariffs to be averted, we believe US-China tensions will remain elevated in the months leading to the November US election. This should see the yuan incorporate some risk premium.
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