FX Outlook 2018

With the US leading the current global economic cycle, there is a growing focus on how the prolonged recovery in the world’s largest economy will influence international currency markets. Of particular importance is the Federal Reserve’s move towards higher interest rates, which could not only impact the US dollar and other G10 currencies, but also emerging market currencies – such as the Chinese renminbi and Malaysia’s ringgit.

Despite the rising rate environment, HSBC expects the US dollar to remain weak. With the exception of the late 1990s, the US dollar tends to depreciate when the Federal Reserve hikes rates. This is because there is no strong relationship between the value of the greenback and US interest rates, said Joey Chew, Director, FX Strategist, Global Research at HSBC.

Ms. Chew, who was speaking at HSBC’s 2018 Asian Outlook and BRI Forum, said that global economic growth can be a much more important driver for the currency. The US dollar’s status as an international financing currency means that when the global economy is strong, sovereigns and corporates all over the world raise debt in dollars, which is then exchanged into their local currency, thus applying downward selling pressure on the dollar.

“We are already in a phase of the global economic recovery where more governments and companies are raising international debt because they want to invest and consume,” said Ms. Chew. “It makes sense that the dollar is weak in this kind of environment.”

Furthermore, the FX markets anticipated the Federal Reserve’s rate hikes, with much of the US dollar’s appreciation actually taking place in 2014, ahead of the policy shift. A similar move has already happened for the euro, said Ms. Chew, due to expectations of a less accommodative monetary policy from the European Central Bank. The next currency to make this kind of adjustment could be the yen, she said.

In Asia, the value of the US dollar is just one of a number of factors that helps direct the currencies. A pick up in global trade for example, helps the region’s trade-driven economies.

“Global trade growth is now approaching the level that we saw in the mid-2000s, so we are expecting emerging market currencies to do quite well,” said Ms. Chew.

The renminbi is also a very important anchor for Asian currencies, she said, since China is a major consumer of Asian exports. The Chinese currency had tended in the past to either appreciate strongly such as during the period from 2005 to 2008 or been stable. The depreciation in August 2015 thus shocked many observers.

“The important message is that the renminbi is no longer depreciating,” said Ms. Chew, which she attributes to China managing to contain the outflow of capital. Going in the other direction, growing confidence in the Chinese economy and its currency will lead to inflows from foreign investors, as well as increased holdings of renminbi deposits overseas.

“We think that this year will be a period of inflows for China,” she said. “But this doesn’t necessarily mean that we are going to have one-way appreciation again, as inflows will allow the Chinese authorities to relax the outflow channel.”

Moving on to the ringgit, Ms. Chew said that the Malaysian currency is having a strong run against the dollar after lagging against its peers. The recovery in oil prices is a factor. So too are expectations that Bank Malaysia Negara could start to tighten its monetary policy.

Going forward, the pace of the ringgit's appreciation may be affected by a potential relaxation of some FX-related measures that were introduced in 2016. For example, residents including sovereign wealth funds and local pension funds, may increase their outward investments. The strength of the Malaysian economy will also affect the value of the ringgit. The buoyancy in the local economy stimulates imports, which will offset exports that are high due to robust oil sales.

That said, Ms. Chew stressed that the ringgit’s trajectory is firmly upward, since all the models signal that the currency is currently trade below its fair value.

“My message is that the fair value of the dollar ringgit pair is definitely below where it is today, and it is only a matter of time before we get there,” said Ms. Chew