FX: Turning up the pressure

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The US economy has continued to recover. This recovery is off a low base after the economic lockdown. Risk assets have started to rebound. We think the medium-term outlook is better than it has been for several years. The global recovery will be supported by very low interest rates. Currencies will become the pressure release valve for economic differences as central bank policy rates are flat on the ground. The currency outlook will take on more importance for investors with offshore exposure.

The USD has dominated.

The US dollar has strengthened against a broad index of currencies for much of the past decade (Fig 1). The reserve currency was supported by relative economic strength, relatively higher interest rates, and more recently, by safe-haven demand. Some of the USD pressure was released when the US Federal Reserve provided dollar liquidity via swap lines in mid-March. But the USD remains elevated.

Fig 1: The USD has strengthened for most of the last decade.

A grinding US economic recovery is on the cards.

Services and manufacturing surveys show that the US economy is already recovering (Fig 2). That recovery will take some time. We think it will take several years to regain the activity lost during covid-19. After the GFC, it took more than six years to recover the employment peaks from before the crisis (Fig 3). It could take even longer this time.

We expect the US will be one of the better growing developed markets. Its flexible labour market, willing fiscal support and innovative central bank will provide a growth edge.

Fig 2: Services and manufacturing PMIs are above 50, pointing to economic recovery.

Fig 3: Total US non-farm payrolls could take years to recover pre-crisis peaks.

A challenging environment to manage FX exposure.

The global economic recovery will be uneven. And central banks will leave monetary policy at record low levels for years to come. Currencies will become the pressure release valve that helps balance economic differences. And the FX movements could be significant in some cases. Making clear decisions on the potential cost of being hedged versus unhedged will be important for investors holding international equities. And investors will need to have the appropriate governance framework in place to implement those decisions.

Our monthly Asset Allocation Review considers a range of currencies and the impact on investment returns over the medium-term. Reach out to our Portfolio Advisory Service to find out how we can assist you with managing the upcoming investment challenges.

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