- A divergence in currency markets has been seen since the end of January.
- Low-yielding, current account surplus currencies have rallied at the expense of the US dollar and commodity currencies such as the AUD and CAD.
- ANZ Bank expects those trends will continue over the next couple of years.
After largely reflecting movements in the US dollar for well over a year, a change is underway across currency markets.
Global growth looks to be close to, or at, its peak, monetary policy is getting tighter, economic data is starting to surprise and volatility has returned, especially in stocks, seeing a division emerge in currency markets.
As seen in the chart below from ANZ Bank, while the euro, Japanese yen and Swiss franc have all rallied against the greenback since January, a move in stark contrast to the performance from the Australian, Canadian and New Zealand dollars.
The current account surplus currencies are in demand while the commodity complex, along with the now high-yielding US dollar, are lagging.
To Daniel Been, Head of FX Strategy at ANZ, the recent moves are likely a sign of things to come, suggesting that after years of being driven by financial market liquidity, the prospects for global growth will once again return to the fore.
“We think we are now seeing the beginning of the end of the Goldilocks thematic in markets and that, like ‘decoupling’ and the other temporary thematics the market has latched onto over time, it will be archived and soon forgotten,” Been says.
“The market now recognises, again, that there is a cost to growth.
“While positive growth is good for the short term, it is increasingly apparent that medium-term stronger growth will only accelerate the pace of tightening and thus generate issues for currencies which have benefited from QE-induced asset allocation decisions.
“Put differently, the market is starting to treat the expansion as decidedly late cycle — a time where a more cautious stance is generally warranted.”
Been notes that after being dominated by a synchronised global economic recovery in 2017, leading to a sharp depreciation in the greenback as capital flowed into other regions, recent evidence suggests the US economy could start to gather steam again, an outcome that could potentially boost the US dollar against higher-yielding peers.
“The US is once again starting to show some growth leadership with the recent ISM report moving higher, in a world where consistently other countries saw deceleration,” he says.
“In a world where the US is set to receive a bit of a fiscal boost, this idea of US growth out-performance could again gain traction, which in itself suggests the current underperformance of cyclical currencies will continue.”
Adding to the challenging environment for cyclical currencies, Been suggests the withdrawal of monetary policy stimulus, leading to the potential for slower economic growth and increased financial and data volatility, could weigh on commodity currencies such as the CAD, AUD and NZD.
“As central banks become net sellers and tech companies — which were huge buyers of credit — stop buying, demand is structurally changing. Similarly, a more aggressive treasury issuance schedule means that supply is rising and crowding-out will start to reverse,” says Been.
“Where before central bank buying of a limited stock of safe assets pushed investors out on the risk spectrum, fewer buyers of an increasing supply of safe assets will mean that the return demanded for riskier assets has to recalibrate to the new reality.”
Been says indicators on financial market liquidity suggest that not only is global growth likely to “turn into a more sustained slowing in the latter part of this year”, but could also lead to more economic surprises and volatility across markets.
“Typically in periods when growth is slowing and the variance of data outcomes are widening, volatility will rise,” he says.
Again, this does not bode well for cyclical currencies.”
Given the balance of risks, Been says the recent divergence in currency market movements will likely persist.
“For some of the lower yielding surplus currencies, the outlook remains pretty good, especially in the JPY, where valuation adds a further tailwind. But for more cyclical currencies that are dependent on attracting capital, like the USD, the outlook remains more challenged,” he says.
“The USD may have a higher political premium attached to it, relative to other higher yielding currencies, but it also has the distinct advantage of being both a reserve currency and the source of significant flows into foreign markets; both of which will provide it with some relative support.”
Looking ahead, ANZ is forecasting that the AUD/USD, currently trading at .7680, will fall to 72 cents by the end of the year before declining to 70 cents by late 2019.
The NZD/USD, sitting at .7260, is tipped to decline to 67 cents and 65 cents respectively over the same period.
In contrast, the USD/JPY is expected to fall to 96 cents by end-2019, down from 105.5 at present, while the EUR/USD is seen rising to 1.3000 over the same time horizon, up from its current level of 1.2410.