Currencies In-Depth

A fleeting greenback rally post Fed rate cut will offer a final chance to reset short dollar exposures. See why undervalued Asian FX are poised to lead the next leg lower in USD and how to position now.

The Indian rupee remains vulnerable to further depreciation amid slowing growth, tight domestic policy, and fragile capital flows. Trade risks and a weakening external balance will likely keep INR underperforming EM Asia peers. 

Despite widespread investor optimism Brazil’s currency outlook is challenged by a toxic mix of poor external, fiscal, and macro fundamentals. Expect BRL to underperform most EM peers. 

Chart 1 Inflation And Bond Yields Are Headed Lower Inflation And Bond Yields Are Headed Lower Turkey’s financial policymakers have pursued a disciplined and restrictive policy mix so far, delivering high real interest rates and curbing fiscal expansion even as the economy slows. This commitment to inflation control has paved the way for a pronounced decline in price pressures, prompting BCA’s Emerging Markets Strategy team to upgrade Turkish domestic bonds to overweight in its EM domestic bond portfolio. Similarly, Moody’s has recently upgraded Turkey’s credit rating and outlook. The lagged effects of the restrictive stance are now increasingly evident: real bank lending rates hover near 30%, real domestic demand growth is decelerating, and fiscal expenditure increases are barely keeping pace with inflation. Collectively, these conditions point to further disinflation and declining bond yields in the coming quarters (Chart 1).From an FX strategy perspective, the Turkish lira (TRY) presents a less precarious profile than many fear and what the forward markets currently imply. Chart 2 Weak Domestic Growth Means Narrow CA Deficit Weak Domestic Growth Means Narrow CA Deficit First, the current account deficit has narrowed considerably in recent years. As tight policy weighs on domestic demand, it will further curb goods imports and keep the current account deficit in check (Chart 2). This improvement should offset much of the expected export contraction due to slowing demand from the European manufacturing sector, reducing pressures on the lira from external balances. Second, the combination of receding inflation and very high nominal yields creates a compelling environment to attract sizable foreign portfolio flows into local currency debt. With foreign ownership of Turkish domestic government bonds currently low by historical standards, there’s significant room for new inflows (Chart 3). As such, the TRY depreciation over the next year will likely fall well short of the 26% pace currently implied by forward markets vis-à-vis the USD. Historically, periods of falling inflation have coincided with slower lira depreciation (Chart 4). A weaker trade-weighted US dollar could reinforce this trend, further curbing pressure on the currency. In this context, short-end local currency bonds are becoming increasingly attractive to global investors. Chart 3 Foreign Holdings Of Securities Are Low Foreign Holdings Of Securities Are Low Chart 4 Falling Inflation Supports The Lira Falling Inflation Supports The Lira Bottom Line: Falling inflation and a narrow current account deficit in Turkey have historically gone hand-in-hand with a less vulnerable currency. This time should be no different: the pace of the lira’s depreciation against the US dollar will likely ease in the coming months.

The yen’s discount, surplus, and rising real rates line up for a multi-quarter surge. Find out why EUR/JPY is the first short and when USD/JPY follows.

EUR/JPY has reached stretched levels, prompting new short trade recommendations across BCA Strategies. The calls are underpinned by compelling valuation, macro, and technical signals.

In this chartbook, we look at the balance of payments across DM and EM countries. The US does not fare well, but neither do a few other countries.

The dollar is breaking down, as capital leaves the US. The important question investors must answer is how much downside is left for the greenback, and whether depreciation will continue in a straight line over the coming months or pause (and even stage a countertrend rally).Tactically, we will be buying the dollar. This is because our technical indicators are telling us that the dollar is much oversold and due for a countertrend bounce.Trade Idea #1: Buy The DXYThe greenback bottomed in 2008, at the depth of the financial crisis and has been in an uptrend since. For the DXY, that trend has been defined by the consistent pattern of higher lows and higher highs since the Great Financial Crisis (Chart 1). Chart 1 The Dollar Is Approaching A Critical Resistance Level The Dollar Is Approaching A Critical Resistance Level Chart 2 The Dollar Is Oversold The Dollar Is Oversold That bull market is now under threat. Year-to-date, the DXY has fallen by circa 10.4%. Given the greenback’s history of moving in very long cycles, the question most investors face today is: Is more weakness forthcoming, or is it time to become a contrarian?From purely technical lens, we will be buying the DXY on Independence Day for three key reasons. The DXY is approaching an important support level. This is defined by the upward sloping trendline, drawn from the 2008 lows, which currently pins support around 96. We will expect at least a tactical bounce at these levels as stale shorts fold their positions.Our comprehensive momentum and positioning indicator shows that the dollar is also very much oversold. Historically, this has led to countertrend bounces in the greenback (Chart 2). This measure is sitting at a standard deviation below the mean. When these levels have been hit in the past, a sharp reversal often ensued. It is remarkable that the higher-frequency momentum component almost hit two standard deviations below the mean.5%-10% rallies in DXY are common within the context of a long-term bear market. This will especially be the case if the world economy enters a recession. The dollar bear market from 2000 to 2008 saw many countertrend rallies, notably in 2005. Similarly, the bull market since 2008 has seen many pullbacks, some as deep as 10%. These have all been tactical trading opportunities.The key message is that the dollar might be going through a regime shift. This regime shift will be more focused on balance of payments, as the reserve status of the dollar is put under a microscope, amidst President Donald Trump’s policies. This is long-term bearish for the USD.That said, for now, the drawdown in the greenback is tactically approaching levels that have typically signaled a countertrend move. That will be around the 96 level for DXY. Trade Idea #2: Oil Producers Versus ConsumersThe dollar is the natural driver of all other FX market moves. This means that if a tactical bounce in the dollar occurs, as we expect, it will weigh on other G10 and EM currencies. The good news is that a few attractive trades exist at the crosses, that are not closely correlated to the overall dollar trend. The clearest one is buying a currency basket of oil producers, relative to oil consumers. There are three key reasons why this trade might prove fruitful:First, most oil producers tend to sport current account surpluses, while energy importers tend to be deficit countries. So naturally, in a world that is increasingly focused on balance of payments, you want to be long a basket of currencies from oil producing nations (Chart 3).Second, with the US being the largest oil producer in the world, the dollar has become a de facto petrocurrency. This means that rising oil prices benefit the US, as they do for Saudi Arabia, Canada, Norway, Nigeria, Angola or even Iran (Chart 4). So, a trading strategy of going long petrocurrencies versus the USD will not work out if one expects higher oil prices. Chart 3 The US Dollar Is A Petro Currency The US Dollar Is A Petro Currency Chart 4 Buy A Select Basket Of Oil Producers Buy A Select Basket Of Oil Producers  Finally, there is very little geopolitical risk premium in the current oil price of $68, which the Kansas Fed estimates as the marginal production cost for US producers. Bottom Line: The correlation between the dollar and oil prices has turned structurally positive (Chart 5). A bearish bet on oil will mean a lower dollar in this case. That said, if the dynamics driving markets are balance of payments, it pays to be long a basket of oil producing nations (that tend to have a current account surplus), versus oil consuming nations. This trade will also benefit from a rise in the geopolitical risk premium in oil prices. Chart 5 Higher Oil Prices Will Lift The Dollar Higher Oil Prices Will Lift The Dollar Chart 6 Buy Precious Metals Buy Precious Metals Trade Idea #3: Buy Precious MetalsAlmost 90% of transactions globally are still conducted in US dollars. For all the talk about de-dollarization, that share has been rising over the last decade. What has been true this year is a clear willingness by foreign nationals to diversify away from this dependence on the dollar. That is true for petro nations such as Russia to geopolitical rivals to the US such as China.For developing nations, the clear choice has been to park their USDs into gold. In 2010, gold was about 10% of central bank reserves. Today, it has become the largest holding by central banks outside the US dollar and the euro.Given that the dollar tends to move in long cycles, the same is true for precious metals. As this diversification away from the dollar continues, gold will still benefit but cheaper precious metals will flare amidst the blaze. We already saw that with silver and platinum prices. The next candidate will be palladium (Chart 6). Chester NtoniforForeign Exchange/Global Fixed Income Strategistchestern@bcaresearch.comFollow me onLinkedIn & X

In this Insight, we highlight our strong conviction trades based on the central bank meetings held by the Bank of England, the Norges Bank, the Swiss National Bank and the Riksbank.  

In this Insight, we look at the best trade idea from the recent rate cut by the Riksbank.