Currency outlook: China may intervene if renminbi/US dollar exchange rate reaches 7.0

by Ray Uy Head of Macro Research and Currency Portfolio Management, Invesco Canada

U.S. dollar: Neutral

We believe the dollar is caught between two macro trends. On the one hand, U.S. growth has positively diverged from the rest of the world, leading to increased interest rate differentials. Higher growth and larger interest rate differentials are typically positive for the U.S. dollar. On the other hand, the U.S. is running large budget and current account deficits. We believe these dueling factors will keep the U.S. dollar in a holding pattern in the near term, but we expect the budget and current account imbalances to eventually drive it lower.

Euro: Neutral

While growing more positive on the euro, we still remain on the sidelines. Most of the macro factors that have driven the euro weaker against the U.S. dollar appear to be fully priced, in our view. Italian politics are the main unresolved headwind for the euro, but we expect a benign outcome.

Renminbi: Neutral

The renminbi/U.S. dollar exchange rate traded between 6.90 and 6.95 for most of October1 but broke above this range late in the month and has since traded between 6.95-6.98.2 U.S.-China politics and trade-related headlines are expected to continue pressuring the pair’s performance. In addition, we see the performance of the U.S. dollar against other major currencies as another major driver of the renminbi/U.S. dollar exchange rate. Capital controls on outflows remain tight, but financial opening will likely continue to increase overseas demand for China onshore assets. We still see 6.80 to 6.90 as the likely trading range, and expect policy intervention if the exchange rate moves towards 7.0.

Japanese yen: Overweight

Despite generally higher global bond yields, the yen appreciated versus the U.S. dollar and the euro in October. In our view, this was caused in part by risk aversion related to the selloff in U.S. equities and Italian government bonds. The market had built up large short yen exposure, and its reversal has probably been driven by short covering. Taking a longer-term view, because we believe the yen remains cheap and is often considered a “safe-haven” currency, it may be an attractive counterbalance to risk assets.

British pound sterling: Neutral

Sterling has rallied around 1.5% on a trade-weighted basis this month, reflecting increased optimism that a deal can be agreed with the EU at the December European Council meeting.3 However, this optimism may have run ahead of reality. There are few signs that the impasse over the Irish border backstop has been resolved. Even if the UK government succeeds in reaching an agreement with the EU, it still faces the difficult task of getting parliament to ratify its proposal. Ultimately, we think an agreement with the EU will be reached and the proposal will be ratified, but the situation is unpredictable and, consequently, we prefer to maintain a neutral position.

Canadian dollar: Neutral

The Canadian economy has performed reasonably well this year with GDP growth and inflation near 2%.4 The Bank of Canada (BOC) continues to believe the economy is at capacity and is hiking interest rates gradually. Recent news of the new trade agreement with the U.S., Canada and Mexico failed to produce more than a brief bounce in the Canadian dollar, and the currency traded weaker over the last month. However, a shift toward a more hawkish tone from the BOC should provide some support.

Australian dollar: Underweight

The Reserve Bank of Australia (RBA) kept its policy rate stable at the October meeting. While it has commented that the next move will likely be an increase, the RBA also stated there is no strong case to raise interest rates in the near term. As the RBA continues to hold rates stable while the Federal Reserve increases the U.S. policy rate, the interest rate differential between the two countries rises, putting further downward pressure on the Australian dollar. The trade war between the U.S. and China shows no signs of abating and could also pressure the Australian dollar, especially if the situation intensifies.

Indian rupee: Neutral

The rupee has experienced a significant selloff this year, especially in the last several weeks, depreciating 12.9% year-to-date against the U.S. dollar.5 This was largely driven, in our view, by an increase in crude oil prices, foreign portfolio outflows and a higher current account deficit. Although we believe risks are still skewed to downside for the rupee, we are hesitant to move underweight at current levels. This is partly because the Reserve Bank of India has apparently intervened in the currency market in recent weeks (as evidenced by the decrease in its U.S. dollar reserves). Further intervention could limit future declines in the rupee.

This post was originally published at Invesco Canada Blog

Copyright © Invesco Canada Blog

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