We believe the main catalyst for currencies in 2015 will be the differentiated monetary policies of the central banks.
As we saw last month, some central banks are already being tested – such as the Swiss National Bank – which has the potential to make this year more volatile than normal in currencies.
The growth differential between the United States and most other developed markets has resulted in monetary policy divergence.
While the US Federal Reserve is on a path towards normalisation, both the Bank of Japan and the European Central Bank will be increasing the size of their balance sheets.
Inflow of funds looking for higher-yielding US dollar assets should continue to support the currency this year.
Meanwhile, with policy rates low globally and weakening inflation data, countries are becoming increasingly reliant on their currencies to boost their economies.
A contraction of the US current account deficit since the 2008 crisis is also providing a structural shift to the dollar.
China’s export-led model is reaching its limit, while the US energy renaissance and gain of competitiveness for the US economy are supporting dollar strengthening. We believe that the dollar outperformance of last year might prove to become the beginning of a multiyear bull cycle.
In our portfolios, we take a conservative approach to currencies, and only take active exposure when we believe the risk-return profile is appropriate within our investment framework. Last year we maintained a long-dollar position, which made a positive contribution to overall portfolio returns.
We believe the divergence between central banks’ action is likely to lead to further weakness in the euro versus the dollar (the Fed is on the brink of tightening, while the ECB has embarked on quantitative easing).
Japan’s prime minister, Shinzo Abe, won another four-year mandate in the snap election and now has momentum to carry on structural reforms.
While he will be looking to increase the pace of the reforms over the coming months, we believe that the next catalyst for a weaker yen versus the dollar will again be on the back of further action from the Bank of Japan.
Non-Japan Asia FX started the year strongly amid relatively cheap valuations following the “taper tantrum”, but reversed course as the pace of the Japanese yen depreciation picked up in the latter half of the year. Differentiation was a key theme, with low yielders underperforming the dollar while high yielders were boosted by positive election outcomes.
Asian FX performance will depend largely on what happens to the yen. At 120 as of end-2014, the dollar-yen exchange rate already concerns many countries in the region, and we expect them to take action to stimulate their economies.
South Korea is likely to be the most active, given policy rates at an already low level of 2 per cent. India and Indonesia should benefit from the positive structural reform trend, but as central banks buy dollars to accumulate reserves, both countries’ currencies should be viewed as a carry and not a spot play. China should continue to anchor the currency via its daily fixings, but the appreciation trend is no longer the one-way trade it used to be.
We believe the oil price will put pressure on commodity exporter currency countries, and therefore emerging market countries will benefit as they have been improving their current account surpluses in the past two years. We continue to be selective in our allocation to emerging market countries.
Cesar Perez is the chief investment strategist for Emea at JP Morgan Private Bank.
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