The 12 months starting July 2014 saw the US Dollar (USD) soar about 20% amid falling oil prices and further monetary easing in Japan and Europe, while the world industrial production growth decline by more than half, from 3.5% to 1.5% during those 12 months. We saw a similar pattern shape up since the start of 2018, but we believe the global economy ex-US might be bottoming out.
A year ago, we argued that the US dollar had peaked and 2019 would be a bearish year for the USD, but it held up against all odds. We believe that there were a number of reasons behind the dollars strength in 2020, including global trade disruption, falling risk appetite of investors and the Fed provided US fiscal stimulus. The worsening sentiment and disruption of global trade channels and the weakening of ex-US global growth helped the USD rally in the initial parts of 2019, and stabilize later on.
However, we believe this might change as global growth seems to be bottoming out, given the JPM global manufacturing survey registered its third monthly increase (albeit a small one). The US and China are apparently moving closer to nailing phase one of the deal which and other geopolitical risks such as the Brexit have declined substantially.
When the global outlook is bleak, global investors are content to ignore valuations as well as wider US budget (and trade) imbalances and pile onto the safety of the dollar. However, this is changing as the USD’s strength is eroding with Fed cutting rates to provide stimulus, whereas other central banks across the global now have much less room for manoeuvre. If the global economies (ex-US) hold up in 2020, the overvalued dollar would be at a risk of losing some ground, and we believe this could be somewhere between 8% to 12%.
While the Euro (EUR) has been out of favour more recently, we believe the overvalued dollar combined with undervalued EUR will help the currency to bounce back in 2020. As long as we see a reasonable conclusion to the US-China trade talks and a better than 2019 year of global growth, the EUR will see positive support over and above dollar weakness.
In terms of FX portfolio allocation, we continue to remain neutral for the EUR at this point. We believe the negative carry from 2019 doesn't help the situation but any meaningful rollback in tariffs and/or rebound in German economy would definitely put us overweight EUR (vs. the USD).
Head of Investment Research