We continue to recommend selling the euro... We see further euro weakness as recent events compound our original concerns on growth and stresses of diverging member economies. Unable to reach political consensus, the eurozone faces significant fiscal austerity that will limit growth and the European Central Bank (ECB) is being forced into quantitative easing as it extends credit and buys member states’ distressed debt. News flow remains negative and there is scope for other central banks to scale back euro allocations in their FX reserves, having bought it at higher prices.
…but the current environment poses risks to all currencies. We forecast a continued global recovery despite the persistence of aftershocks from the financial crisis. However, austerity measures are likely to push several euro member states back into recession and be a drag on growth, even if the debt crisis remains contained as we expect. It is also a difficult environment for other major developed currencies, which share the problems of over-indebted governments and weak growth. Most won’t welcome ‘safehaven’ demand pushing their currencies up and harming competitiveness when exports are key for growth, notably Japan.
We prefer the US dollar, the world’s unrivalled reserve currency. The dollar looks attractive in this environment. At the most basic, the euro’s crisis casts doubt on the major liquid alternative for FX reserves. More positively, we forecast a continued US recovery, even if interest rate increases are now delayed until next year. But the US economy also has its problems, federal debt included, and will not welcome the loss of competitiveness. Still, the dollar remains the liquid, safe haven in an uncertain world.
Commodity currencies and emerging markets are also attractive. The backdrop is more positive for commodity-exporting and emerging economies, especially after the recent sell-off. We would look to buy currencies with growing economies and rising rates, including the Australian and Canadian dollars and a number of emerging economy currencies. However, political considerations are more significant for emerging currencies, with governments reluctant to relinquish economic control in uncertain times.
We are pushing back our forecasts of interest rate increases in all major markets. Outside commodity exporters and emerging markets, which seem set on the recovery path, we have pushed back rate-hike expectations. As noted before, if governments decide (or are forced) to address their record deficits, the resulting squeeze on growth means that rate hikes are likely to be postponed. We still forecast the UK hiking this year, but even this is subject to the new government’s special budget, due to be released 22 June. We do not expect the US to raise rates until next year and further quantitative easing by both the ECB and Bank of Japan is likely before they consider rate hikes.
