Currency Quarterly Q3 2023 | Insight Investment

The global economy has proved resilient despite aggressive central bank tightening, but forward-looking indicators would suggest that the lagged impact of monetary policy is increasingly weighing on growth. For now, the US economy is outperforming, while the Chinese economy has been the most disappointing.

As inflation has subsided, US real rates have risen markedly, with Europe and other developed markets expected to follow a similar path. Higher real rates, combined with slower growth allow central banks to pause, but greater confidence will be needed on the outlook for core inflation before policy can be eased. This status quo is likely to underpin support for the US dollar (USD), but we believe a pullback from recent gains appears increasingly likely. Signs that the Chinese economy may be bottoming could see growth currencies as the primary beneficiary of this move, although broader weakness in the global economy is likely to limit the extend of any upswing.

In our educational topic this quarter, we look at the rise of green protectionism: government policies explicitly designed to expedite decarbonization efforts while incentivizing domestic manufacturing. Climate change, geopolitical rivalry, and the revival of industrial  policy are dividing the world into two competing spheres of influence, increasing geopolitical risks and increasing debt accumulation.

The Alpha view

In our view, a combination of alternative risk premia and macro fundamentals are the key drivers of currencies over short-tomedium-term time horizons. That said, for the moment, we would caution against taking aggressive positions based on macroeconomic fundamentals given the notable cross currents. Indeed, we continue to view 2023 as favoring an environment for more tactical trading than in 2022. A more definitive turn lower in US core inflation could change this. For the moment, the bulk of our recommended currency exposure for medium-term investors stem from our Alt Risk Premia model. As can be seen in Figure 1, it recommends a modest long USD, euro (EUR), and New Zealand dollar (NZD) bias vs. low-yielding currencies such as the Swiss franc (CHF) and Japanese yen (JPY).

Figure 1: Insight Currency Absolute Return Exposure

Source: Insight. Data as of October 4, 2023. Note: Black dot shows aggregate position.

Longer-term valuation overview

As the investment horizon extends to a multi-year window, valuations are likely to dominate the price action in currency markets. We outline the highlights from our long-term valuation model below in Figure 2:

• The USD remains overvalued, but not against all crosses;
• JPY, EUR, and Swedish Krona (SEK) look very cheap by historical standards;
• Australian dollar (AUD) and NZD look moderately cheap;
• British pound (GBP), Canadian dollar (CAD) and Norwegian krone) NOK are close to fair value;
• CHF looks moderately expensive.

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

Source: Insight. Data as of September 14 2023.