Foreign currencies
The EUR outlook has turned marginally positive, as stronger-than-expected growth will keep the pressure on the European Central Bank (ECB) to keep hiking interest rates. While US and UK fiscal policies are expected to tighten, EUR fiscal policy is still projected to be expansionary. It may be worth noting that we favor the CHF since the SNB has been encouraging further franc strength to ward off imported inflationary pressures.
Meanwhile, in the UK, resilience of recent activity and inflation data has supported GBP as rate expectations increased. However, we remain concerned about the structural vulnerability of the pound given the potential for persistent inflation and weak fiscal and external accounts.
Among commodity-linked currencies (AUD, NZD, SEK, CAD, NOK), there may be medium- to long-term opportunities. This could be especially true of currencies of DM and EM trade and commodity-linked countries whose businesses could stand to benefit from geopolitical realignments and “friend-shoring” supply chain shifts. Such beneficiaries, for example, could include Norway, Canada, Brazil, Mexico, and select Asia-Pacific countries. However, we expect a differentiated outcome across these currencies. Select central banks might slow or pause policy normalization cycles earlier because of higher interest-rate sensitivity (housing debt) of their economies — this could act as a near-term drag on their currencies.
Elsewhere, initial rhetoric from the new leadership of the BOJ has reduced market expectations of an imminent policy shift. Governor Kazuo Ueda stated that “the risk of missing our price target with premature tightening is bigger than the risk of experiencing inflation exceeding 2% due to a delayed tightening,” which suggests to us that the recently announced BOJ policy review could delay the normalization timeline somewhat.
However, we continue to believe that policy normalization is ultimately inevitable given growing evidence of a structural change in inflation and wage dynamics post-COVID. The BOJ is trying to manage tension that requires a gradual adjustment out of an inappropriate policy or risk a financial stability issue. As a result, the impact on the yen becomes more difficult (certainly not linear) as the BOJ attempts a smooth exit from ultra-accommodative policy, but ultimately this should be supportive for JPY as we go into the second half of the year.