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Global Currency Outlook Fall 2019

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Global Currency Outlook Fall 2019 HNW_NRG_B_Inset_Mask Global Currency Outlook Trade tensions extend topping process for U.S. dollar FALL 2019 Dagmara Fijalkowski, MBA, CFA Head, Global Fixed Income & Currencies RBC Global Asset Management Daniel Mitchell, CFA Portfolio manager, Global Fixed Income & Currencies RBC Global Asset Management These days, it seems, everyone wants a weaker currency. That includes President Trump, who has been calling for a weaker greenback since taking office in 2017. Yet the U.S. dollar’s resilience continues, largely because the U.S.-China trade war has been pushing down most currencies against the greenback. The U.S. dollar has, in fact, been the best-performing currency for much of the past 12 months (Exhibit 1) as the trade conflict and relatively strong U.S. economic growth have overshadowed the plunge in U.S. bond yields. Global trade tensions are hardly new, but foreign-exchange helps equilibrate global imbalances. It is more politically markets have paid more heed because trade-related and economically palatable for countries to compete on uncertainty tends to dent other currencies more than it trade by letting their currencies fall than taking steps to does the U.S. dollar. Examples of this phenomenon include lower wages or increase fiscal spending. In a world where the Canadian dollar and Mexican peso weakening during economic growth is harder to come by and the fruits of trade North American trade negotiations, the euro softening at are diminishing, few national leaders are willing to venture the prospect of U.S.-imposed auto tariffs and the Chinese along the tougher road of structural reform. yuan falling after each escalation in tariffs. The U.S. dollar’s strength for now seriously complicates President Trump’s With currency markets fighting Trump, an oft-asked question goal of making the U.S. more competitive because the is: when does a trade war morph into a currency war? Our advantage gained from imposing tariffs is quickly lost to view is that currency wars and trade wars are nearly always trade partners’ currency weakness. one and the same. So the next question becomes: what steps can the U.S. take to ensure that a stronger U.S. dollar This is more than just an annoyance for the White House – doesn’t undo all of the perceived benefits of pursuing a that much is clear from recent Trump tweets. But the market trade war? President Trump does have a few tools at his fluctuations are perfectly logical to foreign-exchange disposal: traders. We often refer to currencies as the relief valve that 1 1. The currency manipulator label U.S. Treasury Secretary Mnuchin in early August formally Exhibit 1: Major developed-market currencies over the past year labeled China a “currency manipulator” after Chinese policymakers allowed the renminbi to decline by 2% in a 108 single day, a large move for a relatively stable currency. 106 104 China’s move came in response to the U.S. imposition of 102 a 10% tariff on US$290 billion of imports. Mnuchin was 100 quick to claim that China had been meddling in currency 98 96 markets, even though China meets just one of the Treasury 94 department’s three criteria required to be considered a 92 90 currency manipulator (Exhibit 2). It’s not clear whether any Index level (July 30, 2018 = 100) 88 punishments doled out for currency manipulation would Jul-18 Sep-18 Nov-18 Jan-19 Mar-19 May-19 Jul-19 have a detrimental impact on China at this point because DXY EUR AUD GBP JPY CAD the country is already facing tariffs on the trade front. Note: As at Sep. 3, 2019. Source: Bloomberg, RBC GAM Moreover, the IMF recently reported that the renminbi is fairly valued, undermining the U.S. claim. Exhibit 2 : Criteria to be labeled a currency 2. A weak-dollar policy manipulator Another tool that U.S. policymakers have utilized is verbal intervention, with recent comments aimed at putting downward pressure on the greenback. This is a marked Significant bilateral >20bln departure from the “Strong Dollar Policy” installed in the trade surplus with U.S. mid-1990s by then-Treasury Secretary Robert Rubin and Material current the hands-off approach of benign neglect adopted in later >2% of GDP account surplus years. Given that the U.S. dollar remains the primary means of exchange for goods, services and financial instruments, Persistent 1 sided FX 2% of GDP in these policies form a critical pillar in the foundation of intervention 12 months global commerce. Mnuchin’s comments in January 2018 were the first in several decades to communicate an explicit preference for a weaker currency, so we should not be Note: As at Aug. 12, 2019. Source: RBC GAM surprised to see that markets reacted at the time (Exhibit 3). Interestingly, though, subsequent efforts to jawbone Exhibit 3: Impact of verbal intervention on the the currency lower had an incrementally smaller marginal U.S. dollar impact on markets. 1.0% 3. Foreign-exchange intervention Trump tweets Trump 'EUR Unsuccessful in its attempts to influence the dollar with 0.5% Mnuchin at Trump 'The Fed doesn't devalued Davos 'a comments understand the against the weaker dollar on USD necessary Trade 0.16% dollar putting is good for strength on Wars or Strong the US at a 0.04% words and tweets, the Trump administration is now faced trade' Twitter Dollars... disadvantage' 0.0% Trump Trump 'China & with taking more concrete steps to reverse the greenback’s states that -0.08% Europe playing big USD is too currency strong manipulation game ascent. Direct intervention in foreign-exchange markets is -0.5% -0.42% and pumping money USD change USD into their system in order to compete seen as a last-ditch effort to combat the dollar’s stubborn -0.72% with USA...we should -1.0% match' strength. The debate is whether such a step would achieve -1.02% the goal of pushing down the greenback. We side with -1.5% skeptics who think the impact will be fleeting since history Jan-18 Jul-18 Dec-18 Mar-19 Jun-19 Jul-19 shows that intervention is rarely successful unless it Note: As at Aug. 12, 2019. Source: BofA Merrill Lynch, State Street Global is coordinated globally, and this sort of cooperation is Markets, Bloomberg, RBC GAM unlikely to materialize without a more significant U.S.-dollar appreciation that creates economic distress around the globe. 2 Global Currency Outlook Through the Exchange Stabilization Fund, the Treasury has choppiness in the greenback rather than a sudden reversal some US$68 billion available for intervention purposes, lower. We still expect the choppiness to continue in the short an amount that could be used immediately without term. However, growing fiscal and current-account deficits Congressional approval. That amount could double if the and a narrowing bond-yield advantage will likely lead to U.S.- Fed upholds historical precedent by matching the Treasury’s dollar weakness over the next few years. foreign-exchange purchases, but even that additional firepower would be small compared to the massive size of Chinese renminbi global currency markets, which churn US$5 trillion every All eyes are on the Chinese renminbi after the latest round single day. of tariff increases in August. The currency weakened to almost 7.20 renminbi per U.S. dollar, the weakest since 2008 Furthermore, it would be easy for policymakers in other and a level that was unthinkable as recently as July, when countries to intervene themselves should they wish to the People’s Bank of China (PBOC) was seen to be defending counter the Treasury’s efforts. With foreign-exchange the key level of 7.00. The fact that the Chinese yuan has reserves exceeding US$3 trillion, China has shown its broken through this level is an acknowledgement that the capacity to outgun the Treasury. It is also not clear that currency needs to weaken in response to market forces the U.S. is set up to hold renminbi-denominated assets, so and to escalating trade threats. While the PBOC is active in U.S. intervention would likely focus on strengthening the currency markets, the central bank’s recent intervention has currencies of developed-market rivals instead, namely the been aimed at supporting the currency, not weakening it as euro and yen. is claimed by the White House. This summer’s fluctuations suggest that policymakers in China are not defending any Weighing the outlook particular level, but are instead slowing depreciation in The likelihood that the U.S. engages in foreign-exchange order to avoid disorderly volatility. intervention is low, even as the administration runs out of tools and as it watches smaller countries such Investment banks are predicting that the renminbi will as Switzerland and Thailand weaken their currencies. continue to weaken slowly over the next year, but we Historically, though, intervention has played an important believe the depreciation may be more significant than role in past turning points of long-term U.S. dollar cycles the consensus. According to Bloomberg, only one in 10 so long as other countries are on board with the greenback forecasters expects the renminbi to weaken by more than weakening (Exhibit 4). Another factor that is historically 2% in the coming year. But Citibank’s model, based on the important for concerted efforts to weaken the greenback average level of tariffs applied to China’s US$540 billion in is extreme U.S.-dollar overvaluation. The absence of both U.S. exports, suggests that the renminbi could weaken much conditions is the reason that our currency outlook over the more if announced tariffs are implemented (Exhibit 5).
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