Currency Quarterly Q1 2024 | Insight Investment

Summary

The global economy continues to show remarkable resilience, despite concerns about the lagged impact of interest rate rises. Major central banks have brought their tightening cycles to an end, and now face a careful balancing act in the months ahead. A continued moderation in inflation will add pressure to ease, but economic activity suggests little reason to rush.

In currency markets, the strength of the US economy continues to underpin the stretched valuation of the US dollar (USD), a theme that has persisted for years. A window for USD weakness appears likely to open as the Fed’s easing cycle approaches, but it’s likely to prove limited, with the US election later in the year a potential major source of uncertainty. A second Trump presidency has the potential for major trade disruption given it is likely to usher in a new era of trade protectionism.

We examine the global housing market in our educational topic this quarter. In our view, the fact that house prices have held up much better than expected is a meaningful factor that will make central banks reluctant to cut rates as rapidly as markets expect.

The Alpha view

In our view, short-to-medium-term currency movements are driven by a combination of alternative risk premia (Alt Risk Premia) and macro fundamentals. Our macro investment process suggests there is a window of opportunity for the USD to weaken. This is especially so versus the Japanese yen (JPY) where the expected monetary policy divergence is the greatest.

However, the risk premia factors remain supportive for the USD. As such, our overall preference remains to be moderately long USD, as can be seen in Figure 1

Indeed, in our Alt Risk Premia model, the USD is being supported by both the Carry and Quality factors which are only being partially offset by our Macro factor. We are also moderately constructive on the British pound (GBP), New Zealand dollar (NZD), and Norwegian krone (NOK) and to a smaller extent the Australian dollar (AUD). Against that, we prefer short positions in low-yielding currencies such as the Swiss franc (CHF) and the JPY.

Figure 1: Insight Currency Absolute Return Exposure

Source: Insight. Data as of April 2, 2024. Note: Black dot shows aggregate position.

Longer-term valuation overview

We highlight a few observations for any longer-term investors whose investment decisions may lean more heavily on valuation metrics (Figure 2):

• the USD remains overvalued, but not against all crosses.
• the JPY and Swedish krona (SEK) look very cheap by historical
  standards.
• the euro (EUR), AUD and NOK look moderately cheap.
• the GBP, CHF, and NZD are close to fair value.

Figure 2: Local currency overvaluation (+) and undervaluation (-) versus USD

Source: Insight. Data as of April 2, 2024.