HNW_NRG_B_Inset_Mask Global Currency Outlook SPRING 2021 The U.S. dollar has further to fall Dagmara Fijalkowski, MBA, CFA Daniel Mitchell, CFA Head, Global Fixed Income & Currencies Portfolio manager, RBC Global Asset Management Inc. Global Fixed Income & Currencies RBC Global Asset Management Inc. The U.S. dollar has been in decline for a year following last spring’s pandemic-related panic in financial markets. We expect the decline to outlast the pandemic and persist well beyond 2021, as long-term issues continue to suggest more weakness ahead for the greenback. We have raised our forecasts for developed-market currencies but suspect that emerging markets will likely benefit more from weakness in the U.S. dollar, the recovery in global growth and strength in commodities. The path laid out by past U.S.-dollar bear markets offers some indication of what we should expect in the coming Exhibit 1: U.S. dollar bear-market roadmap years (Exhibit 1). As with the significant long-running declines that began in 1985 and 2002, the first stage of the current U.S.- dollar bear market is proving to be robust – both in terms of 100 the relentless pace of decline and the breadth of currencies 95 90 against which the dollar is falling. Almost all developed- and 85 emerging-market currencies have risen since the U.S. election 80 at the beginning of November. Biden’s election refocused 75 attention on the large U.S. fiscal and current-account deficits 70 (Exhibit 2), and his agenda includes further fiscal support that Indexedto 100 at cycle peak 65 would lead total pandemic-related government spending to 60 55 rise above US$4 trillion, or 16% of GDP. -500 -250 0 250 500 750 1,000 1,250 1985 peak 2002 peak 2020 peak Note: As at Feb. 26, 2021. Source: Bloomberg, U.S. Federal Reserve, RBC GAM 1 The U.S. dollar’s lower interest-rate premium vis-à-vis rivals of these countries lies not in a loss of competitiveness – the (Exhibit 3), and its overvaluation based on purchasing power U.S. dollar is still overvalued, after all. The real problem (Exhibit 4) are other reasons for global fund managers faced by these central banks is that the speed of the U.S. to continue reducing the share of the U.S. dollar in their dollar’s descent reduces inflation in these countries and portfolios. Longer term, Europe and Asia have become threatens the ability of policymakers to maintain inflation more attractive investment destinations given greater at desired levels. The dampening effect on inflation will political cooperation in the EU and an improved economic peak in the second and third quarters of 2021, so we should and technology-sector outlook in Asia. So, we think that expect to hear more from central bankers concerned about temporary rallies in the greenback, like the one that is developments in foreign-exchange markets. In reality, there’s materializing in early 2021, are opportunities to add to bets on very little these authorities can do individually to stop a continued decline in the greenback. the powerful tide of U.S.-dollar weakness. While currency intervention and quantitative easing are huge in historical Until recently, the U.S. dollar’s weakness in 2020 had gone context, they are dwarfed by the US$6 trillion in daily foreign- relatively unopposed. This complacency is ending. Sweden, exchange trading. Chile, Israel and Russia are among the countries whose central banks have indicated they’ll buy dollars to stem the Of all central banks, it is perhaps the Bank of Canada (BOC) rise of their own currencies. The Bank of Japan (BOJ) and that should be most concerned about U.S.-dollar weakness. European Central Bank (ECB) have both begun to hint at their Canada is among the most trade-oriented economies in the discomfort with further currency gains, while China’s central G20 (Exhibit 5), with the U.S. accounting for a much larger bank has loosened restrictions on outbound investment to share of the country’s imports and exports than other counter appreciation of the renminbi. The concern for most developed nations. Exhibit 2: Twin fiscal and current-account deficits Exhibit 3: U.S. dollar’s interest-rate advantage has fallen 140 5 3.0 130 0 2.5 120 2.0 -5 110 1.5 % GDP 1.0 100 -10 Index (level) 0.5 90 1-year swap rates(%) 0.0 -15 80 -0.5 70 -20 -1.0 73 80 86 93 00 07 13 20 Jul-16 Dec-16 May-17 Oct-17 Mar-18 Aug-18 Jan-19 Jun-19 Nov-19 Apr-20 Sep-20 Feb-21 U.S. trade-weighted dollar (lhs) U.S. fiscal + current account deficits, 9m lead (rhs) CAD USD JPY EUR GBP Note: Deficits as at Sep. 30, 2020 and U.S. trade-weighted dollar as at Feb. 26, Note: As at Mar. 2, 2021. Source: Bloomberg, ICE, RBC GAM 2021. Source: Bloomberg, U.S. Federal Reserve, RBC GAM Exhibit 4: Purchasing power parity vaulation Exhibit 5: Exports and imports as a share of GDP U.S. trade-weighted dollar Germany 88 150 Mexico 78 140 South Korea 77 Canada 65 130 France 65 120 U.K. 64 Saudi Arabia 64 110 Turkey 63 100 Italy 60 South Africa 59 90 Russia 49 80 Australia 46 U.S.trade-weighted dollar India 40 70 Indonesia 37 60 China 36 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15 18 21 Argentina 33 USTW$: 86.35 [February 26, 2021] PPP: 80.70 [Feb-21] Brazil 27 20% Band : [64.56, 96.84] U.S.A 26 Note: As at Feb. 26, 2021. Uses new Fed USD index from Dec. 31, 2019 onward. Note: As at Dec. 31, 2019. Source: The Global Economy, RBC GAM Source: Bloomberg, U.S. Federal Reserve, RBC GAM 2 Global Currency Outlook Shades of 2013? Exhibit 6: Emerging-market fundamentals are Recent volatility in the bond markets has some investors stronger than 2013 worried about weakness in emerging-market currencies and a repeat of a 2013 episode when risky assets and currencies plunged. At the time, the U.S. Federal Reserve’s 2013 2020 (Fed) announcement of a reduction in bond purchases Current account (% GDP) -5% 1% caused interest rates to rise and pulled capital away from the emerging world. We think concerns of a similar reaction Over / (under valuation) 8% -18% today are misplaced. For one thing, this year’s rise in yields Foreign debt (% of total debt) 33% 28% is smaller than the 140-basis-point spike during the summer of 2013. Another big difference is that, in 2013, the U.S. dollar Reserves (% GDP) 12% 17% was not in a bear market, and the greenback’s prevailing Note: As at Dec 31, 2020. Data is an average of Brazil, India, Indonesia, South strength at the time acted as a headwind for emerging-market Africa and Turkey. Source: Macrobond, Bloomberg, IMF, RBC GAM assets. Negative real interest rates in developed markets, an abundance of liquidity and a more multilateral approach to international relations in the Biden administration also make Exhibit 7: Estimated capital flows into emerging- for a friendlier environment for risky assets. market assets It is worth acknowledging that emerging-market currency 80 weakness in 2013 was mostly confined to the currencies 60 40 of Brazil, Turkey, South Africa, India and Indonesia. The 20 “Fragile Five” were the countries that were most reliant on 0 foreign-capital inflows because they were running large -20 -40 current-account deficits and had limited reserves to defend USD(billions) -60 their currencies. Today, these countries and other emerging -80 markets are in much stronger shape, with better external -100 balances, larger foreign-exchange reserves and more credible -120 0 50 100 150 200 250 300 350 central banks (Exhibit 6). The large outflows from emerging Days 2013 2015-2019 avg. 2020 YTD 2021 markets last year, in the wake of the pandemic, have not yet fully returned and we think there’s room for further Note: As at Feb. 22, 2021. Source: IIF, RBC GAM appreciation as positions are rebuilt (Exhibit 7). While optimistic about emerging-market currencies as Exhibit 8: Emerging market fiscal spending a whole, we expect the performance among individual countries to vary more than last year. Among the more important factors driving relative performance this year will 18 16 be differences in fiscal health. Some governments responded 14 to lockdowns with large debt-financed spending programs 12 that will weigh on future growth through the increased burden 10 of interest payments. Brazil, South Africa and Argentina stand % GDP 8 out in this regard, not only because they ramped up spending 6 aggressively (Exhibit 8) but also because the aid came 4 mostly in the form of cash handouts, which are politically 2 difficult to unwind. A study by the International Institute of 0 INR IND TRY CLP ZAR ARS PLN BRA PEN CNY PHP COP MYR MXN ROM Finance found that countries rarely return to pre-crisis fiscal 2019 2020 balances after large increases in government spending. The Note: As at Dec. 31, 2020. Source: IIF, RBC GAM most vulnerable countries with large debt loads and a poor history of fiscal discipline will likely see their currencies underperform relative to countries like India and Mexico, 3 which spent more responsibly last year. Another cause for differences in performance will come from regional strengths. Exhibit 9: Range of returns since the beginning Asia is benefiting from booming sales of technology and of 2020 consumer products as well as links to stronger Chinese 15 economic activity.