Play video with
Daragh Maher
By: HSBC FX Strategy
Currencies
Global
February 2020
Currency Outlook
FX and the US elections
We take an early look at how the US election
campaign may be viewed by the FX market. The
growing dominance of risk on — risk off
(RORO) considerations is likely to accelerate as
we head towards the final stages of the 2020
election campaign.
We address the three moving parts of the
election process: selecting the Democratic
Party Nominee, the Presidential Race, and the
Congressional Election outcome.
GBP: Theory of relativity
We believe GBP-USD should rally to by year-
end, as GBP is set to outperform in three relative
lights:
1. Relative to other currencies
2. Relative to recent trends
3. Relative to expectations
Long-term Forecasts
We include our long-term forecasts for G10 and
EM currencies until 2026.
Disclosures & Disclaimer: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix,
and with the Disclaimer, which forms part of it.
Summary
FX and the US elections (pg 3)
We take an early look at how the US election campaign may be viewed by the FX market. The growing
dominance of risk on – risk off (RORO) considerations is likely to accelerate as we head towards the
final stages of the 2020 election campaign.
We address the three moving parts of the election process: selecting the Democratic Party Nominee,
the Presidential Race, and the Congressional Election outcome.
GBP – Theory of relativity (pg 13)
We expected the political certainty provided by December 2019’s clear election result in the UK to create
conditions for a significant rally in GBP. So far, our expectations have been disappointed. But we are not
throwing in the towel just yet. We see GBP-USD rallying meaningfully in 2020 to with EUR-GBP
falling to . We believe GBP-USD should rally to
by year-end, as GBP is set to outperform in three relative lights.
Dollar bloc (pg 19)
Recent AUD-USD and NZD-USD weakness has decoupled from interest rate differentials, which have
moved higher. In our view this does not imply that either currency is cheap. We have good reasons to expect
that this ‘gap’ will persist, as the onus is on global growth to improve to see a meaningful bounce in either
currency. We expect both AUD-USD and NZD-USD to underwhelm those looking for a rebound as
reflected in our year-end forecasts of and respectively.
The China impact – Lowering global growth forecasts (pg 21)
We have cut our global growth forecasts – mainly in EM – due to the impact of the newly named COVID-
19 outbreak.
Data Matters (pg 24)
We analyse how the Fear of Missing Out (FOMO) and an increasingly risk on – risk off (RORO)
environment are impacting multi-asset performances.
Long term forecasts (pg 26)
Given the problems of forecasting out one year, many are understandably reluctant to venture a view for
further out. However, we are aware that a number of our clients have a need for some indication of the
likely FX market direction over a longer-term horizon for planning purposes. So, with some trepidation,
we publish longer-term forecasts until 2026
Key events
Date Event
19 February Nevada ninth primary debate
22
February
25
February
29
February
3 March
4 March
12 March
Nevada caucuses
South Carolina tenth primary
debate South Carolina primary
Super Tuesday: 16 primary
contests RBA rate announcement
BoC rate
announcement ECB
rate announcement
Source: HSBC
Central Bank policy rate forecasts (%)
Last Q1 2020(f) Q4 2020(f)
USD -
EUR
JPY
GBP
Source: HSBC forecasts for Fed funds, Refi rate/Deposit rate, Overnight Call rate and Base
rate
Consensus forecasts for key currencies vs USD
3 months 12 months
EUR
JPY
GBP
CAD
AUD
NZD
Source: Consensus Economics Foreign Exchange Forecasts February.
FX and the US elections
RORO likely to become more dominant during US election season
Markets will likely distill complex US politics into a “good” vs “bad” for
risk appetite
The excitement in FX will be at the fringes of the RORO spectrum with
JPY and CHF at one end and high beta plays at the other
The growing dominance of risk on – risk off (RORO) considerations in the FX market is likely to
accelerate as we head towards the US 2020 elections. It suggests any drama will happen at the fringes of
the RORO spectrum in FX with the safe haven JPY and CHF (and possibly the USD) to compete with the
“risk on” plays such as AUD, NZD and selected EM FX. Of course it’s complicated. There are a
multitude of contenders in play for the Democratic Party nomination for the Presidential race (see US
2020 Election Roadmap, 27 January). Even when this layer of uncertainty is resolved mid-year, the market
will have to move on to the uncertain outcome of that Presidential election. Then the market will need to
layer in the impact of the Congressional elections on the ability of the Presidential winner to deliver on the
election manifesto. But amid the myriad possible outcomes at the end of the election process, the FX
market is likely to distill each leg into a simplistic binary choice as to whether it is “good” or “bad” for
risk appetite.
In this report, we take an early look at how the US election campaign may be viewed by the FX market.
In terms of the election process, there are three main moving parts which we will address in turn. They
are:
1. Selecting the Democratic Party nominee
2. The Presidential race
3. Presidential power / Congressional election outcome
Each element carries its specific complexities and uncertainties but they are still likely to be interpreted
by the currency market in a RORO framework. This means certain currencies are more likely to be
central to the vagaries of the election developments than others. Chart 1 shows the correlation over the
last year of the world’s currencies (based against the USD) with changes in the S&P500, our proxy for
risk appetite. The G10 currencies are marked in black, with the EM currencies in red.
Risk off Risk neutral Risk on
1. FX correlations with S&P500 over the last year
12M correlation w ith S&P500*
* Note: All currency pairs versus
USD Source: Bloomberg, HSBC
In the G10 space, the JPY and CHF clearly remain the safe havens with their negative correlation to risk
appetite. The flipside are the commodity currencies and the SEK (with Sweden’s small open economy) while
the EUR and GBP languish in a no-man’s land of relative indifference. In EM FX, there is little surprise to see
the bulk of them with relatively elevated correlations with risk appetite. It suggests if you have a strong view on
how the run-up to and aftermath of the US election is set to play out, then the wings of the RORO spectrum
offer the best way to play it. Under the circumstances, MXN-JPY may be the best exposure for those who want
to play the US election in FX, be it in terms of spot direction or perhaps volatility. Alternatively, if you have a
strong view on where the EUR or GBP may go, as we do with our year-end forecast of on GBP-USD, the
US election is less likely to impact this exchange rate’s path.
2. The RORO elements of the US election season
Democratic Party nomination process
Presidential election campaign
Democratic Party gains may heighten
policy uncertainty and market concerns
over tax and regulation
Gains for President Trump may be
viewed as fostering continuity and
leaving door open to tax cuts
Congressional election outcome
Gridlock could be viewed as neutral
(continuity) or “risk off” if seen as
preventing further tax cuts
Gridlock could be viewed as “risk on” if
seen curtailing the more radical
Democratic Party proposals
Source: HSBC
Candidate pushing radical or major
policy changes fares well in polls
Candidate with more ‘centrist’ views
fares well in polls
JP Y
C
H
F TR Y
H
U
F E
U
R
IL
S
G
B
P C
Z
K
N
Z
D
SE
K
H
K
D
IN
R
A
U
D
ZA R
C
A
D
ID
R
M
Y
R
R
U
B
TW D M
X
N
Another possible investment takeaway from this approach is to think about hedging out RORO exposure if you
do not want to take a view on the US election. For example, if you strongly believe that the AUD will rally
because the RBA will hike rates, but you don’t want to be exposed to potential risk-off sentiment that would
hurt the AUD, you could buy AUD-NZD or AUD-CAD which might help to neutralise some of the RORO risk
while maintaining a specific view on an individual currency.
Regardless of approach, how does one best arrive at a judgement on the likely path of risk appetite in
the coming nine months? Well, let’s start at the beginning with the Democratic Party’s process of
nominating its nominee to run for President in 2020.
1) Selecting the Democratic Party nominee
The number of names that have expressed an interest in running for the nomination is large, but has been getting
smaller as some potential contenders have already dropped out. Given the tendency of financial markets to
simplify, we can expect the financial markets to focus their attention on the front- runners as measured by the
opinion polls. Recent polls show Bernie Sanders, Joe Biden, Michael Bloomberg, Elizabeth Warren, and Pete
Buttigieg commanding the lion’s share of the vote (see chart 3). Indeed, a model projection by FiveThirtyEight
looking at the likelihood of a candidate securing the nomination at the end of the Democratic primaries gives the
other runners a combined probability of less than 1%. The swings in candidate poll positions and projections in
the wake of the Iowa caucus and New Hampshire Primary illustrate how fluid these measures are.
3. Polls show support is concentrated among a few Democratic Party Nominees
Source: RealClear Politics, HSBC, updated on 12/02/2020
Good vs bad (for risk appetite)
Markets dislike uncertainty and the more radical the policy suggestions being made, the more uncertainty
it creates. Thus, the more radical the idea, the worse it is likely to prove for risk appetite. The “good” vs
“bad” is often not about the merit or otherwise of the policy prescription, it can simply be about the
market’s ability to digest it.
The FX market is also likely to use uncertainty as the basis of its “good” vs “bad” view, because many of
the policy proposals are lacking sufficient detail to allow a useful economic impact to be calculated. In
addition, the leading candidates have opined on so many policy aspects that deciphering what the overall
(and inter-related) impact might be is difficult.
In the early stages of the election, therefore, if the topic is to get traction it is likely to fall along the lines of
which candidate is offering the most or least disruptive cocktail of policies, particularly those that have a
clearer path to financial market performance. Thus Pete Buttigieg’s and Elizabeth
25
%
20
Democrat first-choice (opinion
polls)*
%
25
20
15 15
10 10
5 5
0 0
Sa
nd
er
s
B
id
e
n
B
lo
om
be
r
g
W
ar
re
n
B
ut
ti
gi
e
g K
lo
bu
ch
ar
Y
an
g St
ey
e
r
G
ab
ba
r
d
B
en
ne
t P
at
ri
c
k
Warren’s suggestion to push the corporate tax rate back up to 35% (from the current 21%) might have a
greater adverse impact on risk appetite compared to Joe Biden’s suggestion to raise it to 28%. With so
many months to the election, the market will not want to over-complicate things.
By the same token, Bernie Sanders and Elizabeth Warren’s suggestions for healthcare reform (a multi-
year transition to government-led provision of health care coverage rather than private sector insurance)
represents a bigger shake-up than Joe Biden’s proposed health care reforms. The uncertainty about the
success and cost of the more radical ideas suggest they would be bad for risk appetite.
So we are left with a situation where FX risk appetite is likely to fall along a spectrum, one where signs
that the less radical Joe Biden will get the Democratic Party nomination will be supportive of FX risk
appetite while a rise in support for other candidates could see market uncertainty rise and risk appetite
falter. Of course, the probabilities of who will eventually secure the nomination at the Democratic Party
national convention in July can shift. After the Iowa caucus result, FiveThirtyEight’s model halved the
likelihood of Biden winning the nomination from 42% to 21%, with Sanders racing to 31% and the other
front runners also gaining at
Biden’s expense. Amid the competing factors driving risk appetite (. coronavirus, US economic data),
the early stages of the US election process are perhaps not the dominant consideration. But the traction
enjoyed by the election is likely to rise as the weeks roll on to the Democratic convention and the reality
of the full-fledged presidential campaign.
2) The presidential race
The real deal
Once the uncertainty of the Democratic Party nominee process is cleared, the market will simply move on
to the uncertainty of the presidential election campaign. Opinion polls have been crafted to see how
President Trump might fare against any one of the main potential challengers from the Democratic Party.
The overall picture, unsurprisingly perhaps, is that the result is too close to call. And after 2016, there may
be some reluctance in the market to place too much credibility in the signals being sent by the polls. In the
end, the overall outcome will likely come down to the results of a few key swing states, a number of which
show a significant number of voters as undecided about who they might favour.
In our monthly reviews of FX market developments during the previous presidential election, it was not
until July 2016 that we made the following simple observation – “the US election began to attract greater
focus”. Arguably this year’s election is getting attention a little earlier but from July onwards the election
is likely to get greater traction in the FX market. The Democratic Party nominee process may grab some
attention if it throws up occasional surprises along the way, or offers unexpected clarity early on in the
process. But the FX market has other things on its mind right now, particularly regarding risk appetite.
A known quantity
The campaign proper will be a feature for risk appetite, and once again we suspect the market will want to
simplify the multitude of policy issues, proposals and paths into a “good” versus “bad” narrative. In its
very simplest form, this could be based on the metric of President Trump now being a known quantity to
the financial markets after close to four years as the President. The Democratic Party challenger will be
an unknown quantity, and may carry forward some of the more radical policy proposals that presumably
helped them to win the nomination. The FX market may therefore view a victory for President Trump as
representing continuity for financial markets which would be supportive of risk appetite.
This is arguably in contrast to 2016 when President Trump was the unknown quantity, the upstart who
would shake up Washington and “drain the swamp” as he used to promise. Hillary Clinton was viewed
as the candidate that would offer policy continuity.
4. The USD generally tracked President Trump’s poll ratings in 2016
DXY Index Probability of Trump win*
100 46
99 45
98 44
97 43
96 42
95 41
94 40
93 39
92 38
Apr-16 Apr-16 May-16 Jun-16 Jun-16 Jul-16 Aug-16 Aug-16 Sep-16 Oct-16 Oct-16
Source: Bloomberg, Real Clear Politics, HSBC
Chart 4 shows Bloomberg’s USD index plotted against the average poll rating for President Trump in the
run-up to the November 2016 election. The link is by no means statistically significant but the broad
thrusts of the currency seem to match many of the swings in President Trump’s perceived chances of
success.
Of course, even if we accept that there is some link between these two elements, it does not offer us
clarity on the reason for the link. For example, one could argue that the USD rallied because the FX
market was anticipating better economic prospects under a Trump administration or conversely it rallied
on a safe-haven bid given the uncertainty about what the administration might actually deliver.
If President Trump is viewed this year as the continuity candidate then the relationship between the USD
and his poll ratings could be more complicated than in 2016. But to understand this, we first need to look
at another key element for the USD amid the election campaign, that of fiscal policy.
A taxing time
In the context of “good” versus “bad” for risk appetite, the debate around taxation is likely to be
especially of interest to financial markets. There are other aspects of policy, such as healthcare proposals,
that could have big effects on certain sectors but the ideological divide is perhaps most acute regarding
tax. For financial markets, the tax issue (particularly corporate tax) could be a key driver to the risk mood
response to the vagaries of the opinion polls.
Ahead of the election in 2016 and during President Trump’s efforts to push tax reform through Congress during
2017, there was a market debate about how best to view the prospect of a fiscal stimulus with tax reduction as a
key element. If you wanted to argue it would push down risk appetite, then you would have pointed to the lack of
need for a fiscal stimulus so late in the cycle, leaving the government with no leeway to respond to a future
downturn. You would have flagged how it might exacerbate structural concerns about the size of the fiscal deficit
and level of government debt.
However, in the end the cyclical dynamic outweighed the structural fear factor in the market’s reaction
function. Although it took us a little time, we reached the conclusion that cyclical forces would dominate
structural concerns for the USD a lot earlier than consensus. This prompted our constructive view on the
USD, a counter-consensus line we have retained ever since. The fiscal stimulus when it arrived at the
beginning of 2018 added to the case for Fed tightening,
Profit Margins MSCI USA cumulative announced
share buybacks by year
supported the USD, boosted corporate earnings growth, and helped foster even more share buy-backs by
corporates. The numbers are significant. HSBC estimates that the Trump tax reform added 10ppt to
earnings growth in 2018. So it would have been 12% not the 22% which includes tax changes. The
reforms also added 100bp to profit margins. They added an estimated USD300-400bn of share buybacks.
5. Tax reform in 2018 boosted margins… 6. …and fostered more share buy-backs
USA USA ex
IT
2015 2016 2018
% USA ex IT, ex Tax Europe %
12 12
11
10 10
9
8 8
7
6 6
USDb
n 1000
800
600
400
200
0
2019
201
7
USDbn
1000
800
600
400
200
0
Jan-05 Jan-08 Jan-11 Jan-14 Jan-17
Jan-20
Jan Mar May Jul Sep Nov
Source: FTSE Russell, Refinitiv Datastream, HSBC Source: FTSE Russell, Bloomberg, HSBC
As noted in our first section, the Democratic Party candidates want to roll back, by varying extents, the
tax cuts introduced by President Trump in the tax law of 2017. The front runners are also proposing
higher income taxes on top earners and some have proposed wealth taxes. Bernie Sanders advocates an
“extreme wealth tax”. Of course, we cannot be certain that any reversal of the 2018 tax cuts would cause
an equivalently sized reduction in earnings growth, profit margins or buybacks. But the market would
likely attach a higher probability to a more challenging corporate tax environment if polling for the
Democratic contender were to rise. This would likely have knock-on implications for risk assets, even if
the market knows that campaign pledges do not always end up translating into law. Nothing is certain, but
financial markets operate by gauging and balancing uncertain outcomes. In FX, this divide on the next
steps for taxation is likely to be a key determinant of the reaction function.
Trump tax cuts: same but different
The likelihood that tax plans will be the main pinch point for FX risk appetite may be reinforced from the
Republican side of the equation. President Trump has hinted at plans for further income tax reductions,
aimed at the middle class, suggesting an announcement could be made by the end of April1. The Director
of the National Economic Council, Larry Kudlow, said something may be announced later in the
campaign2.
The lessons of 2018 suggest the cyclical boost of further tax reductions would be USD positive. But there
is a wrinkle. Part of the USD’s strength in 2018 was likely driven by the Fed’s willingness to tighten in
defiance of a market that expected fewer rate increases that year. But the backdrop is different this time
around for monetary policy. The Fed’s ongoing framework review which is seeking in part to remedy the
frequency of inflation undershooting target (see chart 7) might foster a different reaction function to that
seen in 2018. Perhaps the Fed will not respond to lower taxes with higher rates this time around. It may
want to let the economy “run hot” to reinforce its messaging that its inflation target is symmetrical.
1
2
2% target
7. Fed may want to remedy the prevalence of inflation undershooting target
Frequenc
y 20
18
16
14
12
10
8
6
4
2
0
US Headline PCE
Deflator
Frequency
20
18
16
14
12
10
8
6
4
2
0
Source: Bloomberg, HSBC. Note: Since January 1999
This path of loose fiscal and monetary policy should be conducive to risk appetite as a result, even if the USD
implications are less clear. It may also make for an interesting time for the US yield curve if the market truly
believes the Fed is willing to let inflation run hot, with a steeper curve perhaps interpreted as a signal of
diminished recession risk, again adding to risk appetite. The implications for EM FX of this development
would be mixed, but overall a US economy being allowed to enjoy the full fruits of tax cuts without the
headwind of higher policy rates could be helpful to risk appetite particularly if the rest of the world is still
struggling to find growth. Again, this is about probabilities. A rising probability of a Trump victory would not
guarantee tax cuts, but the market would have to attach a higher percentage to that potential “risk on” outcome.
The dominance of RORO in the FX reaction function may be different in other asset classes. For example,
it is conceivable that the equity market will react more at the sector level in response to the shifting
fortunes of the main protagonists. Sectors such as healthcare and tech, for example, may be sensitive to
some of the policy proposals being made by Democratic candidates, while the energy sector may hope for
additional sympathetic policy initiatives from the Trump administration. By contrast, FX will likely
respond at the aggregated macro level across the RORO spectrum rather than obsess about the sectors.
3) Presidential power / Congressional election outcome
Amid the moving parts of who will get to contest the presidential election and who will emerge as victor, there
is the additional consideration of whether the winner will be able to put campaign words into action. This will
hinge largely on the outcome of the congressional elections. If a party can win a “clean sweep” in the elections,
taking the White House, the House of Representatives and the Senate, then this would increase the President’s
ability to push their agenda into law.
That said, most opinion poll projections suggest we will still face a divided Congress after the elections. In the
House of Representatives, the Democrats hold 235 seats against 200 for the Republicans. Projections suggest 23
seats are a “toss up” so the Republicans would need to do very well in those tight races and also turn some other
seats. It is a big task. On the flipside in the Senate, the Democrats need to take a net 3 or 4 seats and only 4 of
those being voted on in this election are projected as “toss up” outcomes. It will be a difficult task for the
Democrats to take the Senate.
- 1.
2
- 1.
0
- 0.
8
- 0.
6
- 0.
4
- 0.
2 0.
0
0.
2
0.
4
0.
6
0.
8
1.
0
1.
2
1.
4
1.
6
1.
8
2.
0
2.
2
2.
4
2.
6
2.
8
3.
0
3.
2
3.
4
3.
6
3.
8
4.
0
8. Projections show how difficult it will be for either party to shift the power dynamic
Democrats
Solid, Likely and
Lean Democrat Toss-
up
Solid, Likely and
Lean Republican Republican
235
219
213
23
31
200
193
190
House of
Representatives
Current composition
Projected by Cook
Projected by Politico
Average
216 27 192
Senate
Current composition
(Seats held up for re-election in
2020) Projected by Cook
Projected by
Politico Average
Source: Cook Political Report, Politico, HSBC
The prospect of a gridlocked Congress may temper the RORO response to the support level of any given
candidate in the Democratic Party primaries or during the Presidential campaign. It could, for example,
reduce the “risk off” response should proponents of more radical policy change begin to enjoy greater
support.
But difficult does not mean impossible and 2016 showed that an election can deliver an unexpected
“clean sweep” outcome. It also showed that even a clean sweep does not guarantee all aspects of the
President’s manifesto are destined to make it into law, swiftly or otherwise. And finally, even if
Congress remains divided, President Trump has shown that executive power can still be impactful on
risk appetite, notably through his use of trade tariffs.
RORO is the way to go
The likelihood that risk on-risk off will become an increasingly dominant part of the FX narrative in 2020
may not feel like such a leap given the start markets have already had this year. In little over a month, they
have enjoyed initial risk-on sentiment based on hope for a global reflation theme, then coped with a steep
but brief escalation in Middle-East tensions, and now are coping with the still uncertain implications of the
coronavirus outbreak. Market moves in 2020 have been framed almost exclusively in a RORO world. But
the reassertion of RORO has been building for a while now as reflected in HSBC’s risk on-risk off
indicator (chart 9). While it is not back to the peaks seen in the wake of the global financial crisis, it is
elevated once again and may be set to rise further if our perspective on the US election season proves
correct.
9. Risk on-risk off is reasserting its dominance
47 53
12 23
11 4 20
11 4 20
11 4 20
Source: Bloomberg, Refinitiv Datastream, HSBC
In the G10 space, this should mean few surprises in terms of the potential winners and losers. Chart 10
shows the correlation of the G10 currencies (based against the USD) versus moves in the S&P500, our
proxy for risk appetite. The red columns show the correlation coefficient over the last year. The grey
columns show the same measure in the year leading up to the November 2016 elections. The behaviour of
these currencies is little changed. The safe haven JPY and CHF are one side of the scale, the higher beta
CAD, and AUD are at the other end alongside the NOK and SEK. In the good vs bad world of RORO
around the election, the G10 drama will therefore likely be centred on the likes of AUD-JPY and CAD-
JPY.
10. G10 correlations with RORO hints any election excitement will be in the JPY crosses
12M leading to 5 Feb 2020 12M leading to 7 Nov 2016
* Note: All currency pairs versus
USD Source: Bloomberg, HSBC
If we also include EM FX in the analysis, the correlation coefficients over the last year are shown in chart 11.
Clearly there are a lot of EM FX plays with an even greater correlation with risk appetite than the G10, and
notable currencies towards the right of the spectrum include the CNY and the MXN. The MXN was deeply
intertwined with the vagaries of the 2016 election given many of President Trump’s manifesto promises held
potentially adverse consequences for Mexico. If the MXN is to repeat its link to election headlines in 2020, it is
more likely to be a function of RORO than any Mexico-specific angle. The CNY has become more intertwined
with RORO as they share the common driver of US-China trade developments. Easing tensions help support
both risk appetite and the CNY, while deterioration typically sees both fall. This inter-relationship is likely to
remain in play in the run-up to the election given the topic is likely to feature at times in the election campaign.
11. EM FX dominates the main "risk on" plays
12M leading to 5 Feb 2020 12M leading to 7 Nov 2016
* Note: All currency pairs versus
USD Source: Bloomberg, HSBC
Correlation with
S&P500*
Correlation with
S&P500*
TR Y
JP Y
H
U
F
C
H
F
IL S C
Z
K
E
U
R
H
K
D
G
B
P
IN R
N
Z
D
ZA R ID R
SE K
M
Y
R
A
U
D
R
U
B TW D
N
O
K
C
N
Y
C
A
D
M
X
N
USD doing its own thing
Amid the scope for excitement on the wings of the RORO spectrum, the USD is likely to be somewhere in the
middle ground. The mistaken reflex would be to assume that electoral developments that are “bad” for
markets would also be bad for the USD. This is not necessarily the case as the USD could enjoy a safe haven
bid under such circumstances. However, the USD’s relationship with RORO is not a steady one, and we are
reluctant to argue that what is bad for risk appetite would always be good for the USD, even if that has been
the most recent experience.
By way of illustration, chart 12 shows the 6M rolling correlation of the USD index with the weekly
changes in the S&P500. Sometimes the relationship is positive, other times negative, but in general it is not
especially helpful. More recently, the latest reading is not meaningfully different from zero. By contrast,
chart 13 shows the same analysis but for AUD-JPY against the S&P500. Although the degree of
correlation varies, it is consistently positive and we can rely on the idea that if risk appetite is rising so too
would AUD-JPY.
12. USD link with risk is fickle and weak… 13. …in contrast to AUD-JPY’s for example
Bloomberg USD Index and S&P 500 correlation AUD-JPY and S&P 500 correlation (weekly chng, 6m
(weekly chng, 6m
rolling)
rollin
g)
Jun-10 Jun-12 Jun-14 Jun-16
Jun-18
Source: Bloomberg, HSBC
-
Jun-10 Jun-12 Jun-14 Jun-16
Jun-18
Source: Bloomberg, HSBC
The idea that the USD will do its own thing is also backed up by previous work we have done looking at
the clustering of different asset types based on the correlations of their price performance. We observe a
“risk on” block and a “risk off” block, but there is also a distinct “dollar” block (see It’s RORO – but
not as we know it). It suggests that cross-asset returns are being driven either by RORO or by the USD.
Again it suggests that the cleanest way to take a view on the US election is to invest at the
fringes of the risk spectrum, rather than look to play the USD against one of the “risk on” or “risk off”
components. The USD will be doing its own thing.
GBP: Theory of relativity
We expected the political certainty provided by December 2019’s clear election result in the UK to create
conditions for a significant rally in GBP. So far, our expectations have been disappointed. But we are not
throwing in the towel just yet. We see GBP-USD rallying meaningfully in 2020 to with EUR-GBP
falling to .
The FX theory of relativity
Einstein’s general theory of relativity provides a mathematical framework for gravitational interactions
across space and time. In simple terms, the theory submits that there is no fixed frame of reference in the
universe: everything is moving relative to everything else. In FX we adopt a somewhat simpler
approach, applying a perspective of relativity onto how different forces apply to different currencies under
varying circumstances. The one overriding similarity is that in FX everything is also relative.
The varying circumstances for FX are which of the broad drivers – cyclical, structural or political – is going to
be dominant for a currency’s behaviour. We believe that cyclical forces are going to be dominant for GBP.
Once we have determined which driver will likely be dominant, we can then think about how this looks in the
relative world of FX. Currencies are generally traded and valued against other currencies, so we therefore have
to think in relative terms. When thinking cyclically, we believe there are three key areas of relativity for
assessing a currency’s outlook:
1. Relative to other currencies
2. Relative to recent trends
3. Relative to expectations
This framework can help to explain why currency weakness might not occur even if a currency’s
fundamentals look terrible on a stand-alone basis. Despite looking soft in absolute terms, if those
fundamentals are better than elsewhere, better than what was expected or are improving relative to a prior
trend, then a currency can still appreciate. On all three fronts, we believe there is room for GBP to
rally, especially given the currency remains some way below estimates of long-term fair value.
GBP to gravitate towards cyclical forces
It is easy to think that politics will remain a crucial component when thinking about GBP in 2020. Chart 1
shows the correlation between UK-US interest rate differentials and GBP-USD. The higher the line, the
more dominant the cyclical forces on the currency. Since 2018 the cyclical relationship between rates and
FX has been relatively weak, suggesting that politics has been the dominant driver of the currency.
Insanity is doing the same thing over and over again and
expecting different results
(Mis)attributed to Albert Einstein
1. Politics has been dominant but is swinging back to cyclical forces
Correlation between 1Y1Y ratedifferential and
GBP-USD
Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
Source: Bloomberg, HSBC
Many might think this will continue. But we are already seeing this change. Post-election the relationship
has already spiked, suggesting there are already signs of this cyclical dominance coming back, although
this could be a flash in the pan. So why do we believe the market’s focus will shift more permanently?
In some respects we have been here before. In 2017, after a politically dominated 2016, we expected
GBP to remain under pressure from those same forces. We were proved wrong, as political factors
moved to the sidelines. The Article 50 notification provided a long enough time horizon for markets to
park concerns around Brexit, and cyclical factors came to the fore as growth bounced at the start of
2017, and the Bank of England hiked rates later in the year.
We don’t wish to make the same mistake by expecting a different outcome in terms of GBP
performance. To paraphrase Einstein’s alleged words, this would be the definition of insanity.
So this time, with the Brexit deal agreed and the UK leaving the EU on 31 January, we believe political
factors will again become a less important driver of the currency. Many market participants and media
commentators are quick to point to the risks of ‘no deal’ at the end of 2020. But previous fears of a ‘no
deal’ proved to be unfounded in both March 2019 and October 2019. The fear of a ‘no deal’ at the end of
2020, or even by June 2020 as some are focused on as the potential deadline this time around, should also
subside. Cyclical factors are set to take over in 2020 with the possibility of a rebound in the UK economic
data. In this space, relativity favours a stronger GBP.
It’s all relative for GBP
Once we have determined which driver – cyclical, political or structural – will likely be dominant for a
currency, then we can apply our FX theory of relativity. As mentioned earlier, we see three key areas of
relativity for assessing a currency’s cyclical outlook. We will now address each one in more detail, but
on all three fronts, we believe there is room for GBP to rally.
26 w eeks, weekly
changes
GBP
political not
cyclical
f
1) Relative to other currencies
UK economy rebounding
Global growth looks set to slow, while HSBC’s economic team are looking for something of a
stabilisation in UK growth. This relative expected improvement in UK growth looks quite stark when
compared directly to the likes of the US and the Eurozone. Charts 2 and 3 show the annual growth rates
we expect each quarter through 2020. It seems clear that from a relative economic growth perspective,
the UK is going to be in a better place than the US and Europe.
2. UK economic growth seen improving
relative to the US…
US UK UK-US diff,
RHS
3. …and significantly outperforming the
Eurozone in 2020
EZ UK UK-EZ diff, RHS
% y
/y
ppt
-
-
-
-
-
-
-
-
Q3 2019 Q4 2019 Q1 2020f Q2 2020f Q3 2020f Q4 2020f Q3 2019 Q4 2019f Q1 2020f Q2 2020f Q3 2020f Q4 2020f
Source: HSBC Economics estimates Source: HSBC Economics estimates
This relative difference may be all the more important in a low-for-longer world, in our view. We have
previously suggested that when interest rates get close to the zero bound, marginal changes in rates can
matter more for FX (see G10 FX: Hypersensitive to rates, 24 November 2015). So a 25bp hike from 0% is
more meaningful for a currency than a 25bp hike when base rates are at 5%, for example. The same may
be true from a growth perspective. When growth is so low, and with ongoing stagnation expected
elsewhere, any sign of a pick-up in UK growth versus other G10 economies could be a very strong
positive for UK assets and for GBP, which have been unloved by investors for the last few years.
2) Relative to recent trends
The only way is up?
It is easy to see why GBP has been unloved. The data have clearly been deteriorating. Chart 4 shows a diffusion
index of a broad range of data, averaged over the last 12 months. When the index is in negative territory, as it
has been since late 2017 for the most part, it means more UK data is weakening than is strengthening. The
current narrative, for example the Bank of England’s dovish shift in late 2019 and early 2020, appears to
assume an extrapolation of the weak trend.
ppt% y
/y
UK activ ity data diffusion index*, 12m moving average
%
GfK UK consumer confidence
(RHS)
Imagination is more important than knowledge
Attributed to Albert Einstein
4. UK activity data in a downtrend
Data improving vs prior Data deteriorating vs prior
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
* Index uses the same economic activity data as the HSBC UK Activity Surprise Index; please see the latest publication for a full
list of the data Source: Bloomberg, HSBC
The above (alleged) quote is relevant when thinking about the GBP outlook for 2020 with a cyclical bias.
Right now, we know that the recent economic data in the UK was softening and it is easy to think those
trends will continue. But we have to use our imagination to some extent to think about how things might
look now that we have a completely different political situation versus what has prevailed for the last few
years. Two examples of how recent trends could shift very quickly are consumer confidence and business
investment.
Consumer confidence has been stagnant for the last few years despite a positive real wage story (Chart 5).
Of course it may be a complete coincidence that this breakdown became much more apparent as political
instability increased. But it is also plausible – even likely – that political uncertainty has had some negative
impact on confidence. Real wages are likely to remain resilient with low inflation and a tight labour
market. So there is every possibility that consumer confidence might rise to close the gap that has opened
up now that UK politics looks more stable. Of course, this requires a leap of imagination to think the most
recent trends will no longer continue and actually an old relationship might take hold.
5. Consumer confidence could bounce 6. Investment has room to play catch up
Real average weekly wages
(LHS)
4
12
Gross Fixed Capital Formation YoY
UK Net FDI, 4q sum, % GDP
3 6
2 0
1 -6
0 -12
-1 -18
-2 -24
-3 -30
-4 -36
12 12
% % GDP
8 8
4 4
0 0
-4 -4
Jan-10 Jul-11 Jan-13 Jul-14 Jan-16 Jul-17 Jan-19 Mar-10 Mar-12 Mar-14 Mar-16 Mar-18
Source: Bloomberg, HSBC Source: Bloomberg, HSBC
Similarly, the trend of investment has been very poor – both in terms of domestic investment and FDI
(Chart 6). But that has obviously been against a backdrop of political uncertainty.
Investment growth, while already on a softening trend, fell most sharply from mid-2016 onwards. The fall
in FDI at around the same time is even more notable. It is possible this had nothing to do with the UK’s
EU referendum outcome in June 2016. But this seems unlikely.
Now that there is a more stable backdrop on the political front, it is not hard to imagine that there is at
least some pent-up investment demand from UK corporates, which has been sorely lacking in recent years.
Similarly, for foreign investors who may have harboured some concerns either about a ‘no deal’ Brexit, or
a left-wing Labour government, at least some of those worries will now be dissipated. While it may be
easier to extrapolate the recent trends, we believe the market might be under-pricing the possibility of a
rebound through both of these channels.
3) Relative to expectations
Consensus fears the worst
So in trend terms, UK economic data have been deteriorating. But the data have also been weak relative to
expectations. Given the narrative is for an extrapolation of the downward trend, we see good reason to
believe that economic performance relative to expectations could revert higher. Chart 7 shows the 3m
change in HSBC’s UK economic activity surprise index. The index was falling at a very fast pace in Q4
2019, showing that data has been coming in worse than expected. But it is rare for such weakness relative
to expectations to persist. Indeed, a bounce already appears to be occurring.
7. UK economic data has been surprising to the downside
UK Economic Activity Surprise Index 3m change +/- 2 st. dev
25
20
15
10
5
0
-5
-10
-15
-20
-25
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
Source: Bloomberg, HSBC
Consensus expectations should be somewhat adaptive, so as data deteriorates, expectations fall as well.
The risk now is that the consensus adapts to, or extrapolates, the recent data trend and looks for even
worse data in the coming months. In that light, even a stabilisation in economic activity would end up
being better than the expectations. The FX market should largely reflect what is expected at any given
time and therefore any improvement in data relative to expectations would be GBP supportive.
An example of GBP already outperforming relative to expectations is the recent developments with the Bank
of England. After disappointing (albeit pre-election) data, a rate cut by the BoE was c50% priced in for the
January meeting. The BoE voted 7-2 to keep rates on hold, a decision which likely factored in the bounce in
post-election data, and GBP rallied following the decision.
Conclusion – GBP has relative value
Einstein’s work on relativity built on that of Sir Isaac Newton’s around gravity. Newton said he could
“calculate the motion of heavenly bodies, but not the madness of people.” In a sense, forecasting FX, which
is often driven by irrational human behaviours rather than cast-iron economic relationships, can often feel
even more difficult than predicting complex physical interactions. Where Einstein’s theories of relativity
help with the latter, we hope our FX theory of relativity can help with understanding the confusing
interactions of currencies.
The outlook for the UK economy may not be for a blast-off. Political uncertainty may not have been
completely eclipsed. And the current trend of both data and surprises is clearly negative. But in our view,
in the relative world of FX, all that is needed for GBP to rally is some kind of relative
improvement, whether that is versus other economies, versus the prior trend or versus expectations. We
think there is potential for the UK to outperform on all of these metrics as it moves into a more cyclical
orbit. This suggests that there is plenty of room for GBP to rally in the coming months, especially as
the currency has been a popular short for the last few years and remains some way below its long-term
fair value range. We see GBP-USD moving to this year with EUR-GBP dropping to .
This is an updated version of GBP: Theory of relativity, 16 January 2020.
Dollar bloc
Conscious decoupling
AUD-USD and NZD-USD have both fallen more than 4% since the start of the year, largely retracing their Q4
gains. Interestingly this has seen both currencies decouple from interest rate differentials, which have moved
higher (charts 1 and 2). In our view this does not imply that either currency is cheap with good reasons to
expect that this ‘gap’ will persist. Instead of relative rates, the onus is on global growth to improve to see a
meaningful bounce in either currency. Since this is not our central case we continue to expect both AUD-USD
and NZD-USD to underwhelm those looking for a rebound as reflected in our year-end forecasts of
and respectively.
1. Antipodean currencies have fallen… 2. …even as interest rate differentials have
risen
AUD-USD AU-US 2Y rate differential
(rhs)
9
8
7
6
5
4
3
2
NZD-USD NZ-US 2Y rate differential (rhs)
Jun 19 Aug 19 Oct 19 Dec 19 Feb 20 Jun 19 Aug 19 Oct 19 Dec 19 Feb 20
Source: HSBC, Bloomberg Source: HSBC, Bloomberg
Rates and FX: not what they seem
We recently studied the way that many conventional ways of looking at FX have broken down, including
rate differentials (Currency Outlook: FX Rules OK! November 2019). The factors we highlighted that
govern this new way of thinking also seem to apply for the AUD and the NZD. In particular, both
currencies have firmly entered the low for longer rate world which, when coupled with low FX volatility,
has left the market to focus more on the simple fact that the USD has the highest yields in G10 rather than
how big that yield advantage is.
The other reason why this breakdown might persist is that monetary policy may be giving less of a
signal about the future health of the economy than might be expected. As we have long argued, it is not
positive for high beta currencies such as the AUD and the NZD if rate differentials narrow because US
rates are falling faster than local equivalents as has been the case recently. The proximity of the lower
bound and possibility of unconventional policy is an important factor that is not captured in simple
rate differentials.
%
%
Leverage concerns have also re-entered the discussion lately. In Australia, economic activity was already
weak before the downside risks from bushfires and coronavirus emerged. Yet the RBA signalled at its
February meeting that it is unlikely to respond to the clear downside risks by cutting pre-emptively, as the
market had been anticipating, instead placing more emphasis on the negative issues associated with easy
monetary policy. This has caused market rates to rise
from low levels but does not improve the cyclical outlook for the AUD. In fact the marked
underperformance of the SEK and the NOK last year despite policy tightening suggests that the market
actually discriminates against those currencies where policymakers try to defy gravity.
Similarly for the NZD, short rate differentials have risen further reflecting some better domestic data at
the end of last year and a less dovish RBNZ. Yet we struggle to see how the cyclical picture will
meaningfully diverge from major trading partners of China and Australia given the close economic links
and small open nature of the economy. In fact, when thinking about the impact of coronavirus, New
Zealand seems to be among the most directly exposed with spending by Chinese tourist’s accounting for
% of GDP, three times higher than Australia (RBNZ Observer, 7 February). The implication is that the
NZD is unlikely to track short rates higher even if the RBNZ stays resolute on the domestic data.
3. Commodity correlations have picked up to
five-year highs…
AUD-USD NZD-USD
4. Pick-up in global growth proxies
necessary to see FX appreciation
AUD-USD Commodity index
May-15 May-16 May-17 May-18
May-19
Source: HSBC, Bloomberg,
-
-
-
-
Feb 15 Feb 16 Feb 17 Feb 18 Feb 19
Feb 20
Source: HSBC, Bloomberg
112
107
102
97
92
87
82
77
72
*Based on 3m correlation of weekly changes in FX vs Bloomberg Commodity Index
Think global
Given these factors it seems unlikely that either currency will magically drift back to the level implied by the
previous relationship with relative rates. Instead of studying the intricacies of monetary policy and the local
economic data, we think it is the outlook of the global economy that will dictate the fate of antipodean
currencies in the coming months. A pick-up in global growth expectations is a necessary condition to see
sustained appreciation in the AUD and the NZD in our view.
There are already signs of antipodean currencies “thinking globally” with the correlations between
commodity prices – a good global growth proxy – and antipodean currencies rising to five year highs (charts
3 and 4). This saw both currencies appreciate towards the end of Q4 amid the global reflation trade before
falling sharply in January as the optimism was subsequently punctured.
Given this focus, we note that our economists have downgraded their global growth forecasts further in the near-
term, and expect 2020 as a whole to see weaker growth than 2019 (see page 21). In line with this we do not
expect antipodean currencies to bounce, as reflected in our year-end forecasts of
and for AUD-USD and NZD-USD respectively.
Correlation v s commodity prices*
The China impact
Lowering global growth forecasts
Janet Henry
Global Chief Economist
HSBC Bank plc
@
+44 20 7991 6711
Edward Parker
Analyst
HSBC Bank plc
@
+44 20 3359 7563
China and the world
We have cut our global growth forecasts – mainly in EM – due to the impact of the newly named COVID-
19 outbreak.
What we know and what we don’t
Over the past few weeks much ink has been spilt by commentators, economists, and analysts about the
financial market and global economic scenarios that could unfold as a consequence of
the COVID-19 outbreak. Historical comparisons with the likes of SARS in 2003 are rife and we now know a
little more about the rate at which the virus is spreading: SARS death rate was higher, but COVID-19’s
infection rate is higher. But there is still much that is highly uncertain, most importantly its severity and
duration, which we may not have a clear picture of for some time.
There are, however, two things that we know for sure. First, China now plays a much bigger role in the
global economy than it did 17 years ago. Whether gauged by its share of the global economy, contribution
to global growth, or share of world trade, chart 1 illustrates that China is twice as important as it was in
2003. Moreover, the share of global tourist arrivals and spending have risen enormously, while its share of
global commodity demand has risen to 50% from 20%.
1. China’s importance in the global economy has doubled since SARS in 2003
% Mainland China %
35 35
30 30
25 25
20 20
15 15
10 10
5 5
0 0
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020
Share of global GDP (PPP terms) Share of global GDP growth (PPP terms)
Share of world imports of goods Share of world exports of goods
Source: IMF, HSBC. Note: 2009 is interpolated for share of global GDP growth.
Second, although uncertainty regarding the virulence and duration of COVID-19 persists, the measures
put in place to contain the virus and the public’s reaction to it are already having an economic
impact. Transport, tourism, retail, restaurants, education, and many areas of manufacturing production in
mainland China have all been severely disrupted or curtailed, prompting our China economics team to
downgrade their 2020 GDP forecast to % from % (see Greater China economics: The hit to GDP
from the coronavirus, 12 February 2020). While they examined a range of scenarios from optimistic to
pessimistic, this base case scenario assumes the virus gradually becomes better contained over the next two
months, allowing for a partial recovery in activity in Q2.
mailto:@
mailto:@
mailto:@
The hit to Q1 growth is material. We now expect mainland China's GDP growth will likely slow to % in Q1
and % in Q2 from % y-o-y in 4Q 2019. Policymakers have already started to deliver stimulus, which
should limit the hit to growth and the pace of recovery when the virus wanes. Based on a SARS-like timeline,
our base case scenario has growth in China reviving to % in Q3, due to re-stocking, activity starting to return
to its underlying level, and more accommodative policies.
The direct impact of lowering our China growth forecast as well as the knock-on impact of the virus itself on
confidence and activity, inevitably has implications for at least the near-term growth picture elsewhere. The
channels of influence of COVID-19 on the global economy are numerous: from weaker China trade and
tourism, to supply chain disruptions, to commodity price declines, and uncertainty itself. The ability to deliver
offsetting policy stimulus will be important too.
Having kept our 2020-21 global growth forecasts steady back in December (see Global Economics: Carried
by consumption, 16 December 2019), we now lower our near-term economic expectations for many other
countries, particularly those in Asia. Our global growth forecast for 2020 (calculated on the basis of nominal
GDP weights) has fallen to % from %.
2. Key forecasts
% Year GDP
2019f 2020f 2021f
World () () ()
Developed () () ()
Emerging () () ()
US () () ()
Mainland China () () ()
Japan () () ()
India* () () ()
Asia ex Big Three () () ()
Eurozone () () ()
UK () () ()
Russia () () ()
Brazil () () ()
Source: Note: *India data in fiscal year (2019 = April 2019 to March 2020). GDP aggregates use chain nominal GDP (USD) weights and Inflation aggregates
calculated using GDP PPP (USD) weights. Parenthesis show forecasts from the Global Economics Quarterly Q1 2020.
We also know that global growth was stabilising but far-from-stellar at the start of the year and many
commodity prices have already fallen back over the past month or so.
A summary of the revisions to our country and territory GDP forecasts and brief explanations is on page
23. This is a shortened version of The China impact – Lowering our global growth forecasts (12 February
2020).
3. Changes to our 2020 Global GDP growth forecasts
GDP growth forecast
Economy revision Explanation
Mainla
nd
China
% to % Virus outbreak and tough measures to contain it are causing significant slowdown in transportation, catering,
retail sales and factory production. We assume virus gradually becomes better contained in the next two
months, allowing for a partial recovery in activity in Q2 (see Greater China economics: The hit to GDP from the
coronavirus, 12 February 2020).
Hong Kong % to % Tourism, trade, supply chain disruption, and domestic consumption
Taiwan % to % Trade and some supply chain disruption, as well as some domestic impact of virus on domestic consumption
Australia % to % Tourism and China import-demand related
New
Zealand
% to % Bigger hit than Australia, because of greater importance of China tourism
Thailand % to % Tourism plays a big role, but there is also an ongoing 2020 budget delay and a drought, so local downside
risks as well as China impact
Philippines Unchanged at % Q4 GDP was higher than expected, offsetting our assumption of hit from China
Vietnam % to % Tourism and supply-chain related manufacturing impact
Singapore % to % Tourism and trade, but also a probable larger fiscal impulse now
Indonesia % to % Low tourism sensitivity, and latest hard data stronger than we had pencilled in
Malaysia % to % Tourism, manufacturing, and LNG prices
Japan % to % Tourism primarily, but also chance of bigger fiscal support
Korea Unchanged at % China impact from tourism and supply chain disruption in Q1 offset by upside surprise to GDP in Q4 2019
India % to % Partly China, partly soft demand trajectory
Sri Lanka % to % Mainly tourism
US Unchanged at % China impact poses downside risks to business investment but offset by upside risks to our current consumption
forecasts
Germany Unchanged at % Downside risks have risen given 12% of exports go directly to mainland China, but we were already assuming
a significant drag from net trade through 2020 and weak investment growth.
France % to % Strike disruption to GDP in Q4 should unwind, with any COVID-19 impact meaning the rebound could be
spread across H1. But underlying growth appears a little weaker and we revise down our 2020 growth
forecast by to %.
Italy % to % Italian GDP contracted by % in Q4. While some of this may have been due to one-off effects, we
assume trade weakness persists and revise down 2020 growth from % to just %.
Spain % to % Spain should be relatively resilient to the China slowdown, but alongside a slightly weaker domestic
demand outlook, we nudge down 2020 growth to %
Eurozone Unchanged COVID-19 impact somewhat offset by upward revision to GDP in 2019 Q3 (driven by non-‘big 4’). Downside
risks have risen & weaker Asian growth strengthens our conviction in our sub-consensus GDP forecast.
UK Unchanged at % Limited direct exposure to China. Q1 growth forecast edged lower but offset by upward revision to Q4 2019
South
Africa
Unchanged at % Downside risks from COVID-19 and slower China growth, but some positive offsets (. precious metal
prices)
Argentina Unchanged at -2% Limited exposure to China and late 2019 activity stronger than expected.
Chile % to % Weak data in late 2019 and anticipated negative impact from copper reflecting weaker China demand & prices
Brazil % to % Largely through lower prices & volume growth for exports of iron ore, soybeans & other agri commodities
Source: HSBC
Data Matters
Mark McDonald
Head of Data Science and
Analytics
HSBC Bank plc
@
+44 20 7991 5966
Max Kettner*
Multi-Asset Strategist
HSBC Bank plc
@
+44 20 7991 5045
Alastair Pinder, CFA Global
Equity Strategist HSBC
Securities (USA) Inc.
@
+1 212 525 4131
Shiva Joon
Data Scientist
HSBC Bank plc
@
+44 20 7991 1356
Subhrajit Banerjee, CFA Fixed
Income Strategist HSBC Bank
plc @
+44 20 7991 6851
Dominic Kini
European Credit Strategist
HSBC Bank plc
@
+44 20 7991 5599
* Employed by a non-US affiliate of
HSBC Securities (USA) Inc, and is not
registered/ qualified pursuant to
FINRA regulations
The last decade was marked by one of the longest developed market equity bull runs in history. As the
decade progressed, Fear Of Missing Out (FOMO) increasingly characterised investor behaviour. With
ultra-low and – in some markets – negative rates, investors were forced to buy virtually any asset with a
decent yield, even low quality ones. With multiple rounds of central bank stimulus, risk assets performed
strongly as investors became convinced that significant sell-offs in these assets would be strenuously
fought by policymakers.
Falling rates lifted all asset classes
The trend towards lower yields has been a fairly constant theme throughout most investors’ lifetimes.
However, the last ten years saw an intensification of the rally in DM rates markets with yields moving to
extremely low levels around the world – to the disbelief of many investors.
Indeed, our fixed income strategists have labelled the past decade The decade of denial
(9 January 2020) for their asset class.
If we look across asset classes though, it is clear that the past few years have provided a very
accommodative environment for investors. Essentially, global bond yields stuck at rock-bottom levels
triggered buzzwords such as ‘hunt for yield’, ‘FOMO’ or ‘there is no alternative’ (TINA).
1. Annual asset-class total returns (%)
Source: Bloomberg, Refinitiv Datastream, HSBC
On the one hand, investors were mostly able to harvest capital gains from rising bond prices. Yet, on the
other hand, ever lower bond yields forced them to go down the quality ladder as well to generate decent
income and returns. This resulted in the ‘goldilocks’ backdrop that we can see in Chart 1 – particularly in
2016, 2017, and 2019, where almost all asset classes posted positive total returns.
mailto:@
mailto:@
mailto:@
mailto:@
mailto:@
mailto:@
mailto:@
We think such ‘goldilocks’ periods should be more short-lived in the future. In any case, we think
they are unlikely to dominate the next decade as much as they have in the last few years.
Put simply, bond yields and (IG) credit spreads are so low now that they provide little cushion for
losses in total return terms. For risky assets such as high yield, EM debt or equities, the now-depleted
fire power of global central banks means that risk-off periods may not be cushioned as quickly and
effectively by more monetary easing.
During the 2020s we think FOMO will be more keenly balanced by another fear: the fear of losing money.
This should lead to greater differentiation amongst asset classes, resulting in better opportunities for active
investing.
Meanwhile, Risk On – Risk Off (RORO), which became a major feature of financial markets after the
2008 global financial crisis, came back strongly towards the end of 2019 (chart 2). During the “Peak
RORO” period at the beginning of the 2010s, the strongest cross-asset correlations occurred at a time
when traditional measures of market stress, such as volatility, had retraced. We see similar behaviour with
intensifying correlations whilst cross-asset volatility is as low as it was in 2014. We believe this signifies
that the market might be subject to more stress than it first appears to be.
2. The strength of RORO as a market driver has surged recently
Source: Bloomberg, Refinitiv Datastream, HSBC
How will this influence markets?
In a way, FOMO has helped fuel the incredible growth of passive investing. After all, why invest actively,
if virtually all asset classes are reliably increasing in value? If, however, we are correct in our above
assumptions, it’s not all bad news for active investors. Larger differentiation across asset classes might
result in much better opportunities for active investing in the next decade. In contrast, intensifying RORO
correlations in conjunction with subdued cross-asset volatility suggest that market stress might be being
underestimated.
The deep dive into the data which powers Data Matters is now available as a separate document, Data
Matters Chartpack. The document at this link contains charts analysing returns, volatility, and correlations
across a wide variety of asset classes.
This is a shortened version of Data Matters – FOMO and RORO (30 January 2020).
Long-term forecasts
Valuations are a long-term effect
In other asset classes valuation is often at the forefront of the investment process. In contrast, for many FX
investors, valuations are considered only rarely. Valuation is inherently a long-term effect: prices can
remain away from fair value for a long time and, in the short term, other factors are likely to dominate.
However, valuations do still matter: large deviations from fair value suggest a tension that is likely to
correct. Indeed, the larger the gap between the price and fair value, the stronger the correcting force is
likely to be.
Fair value ranges
Valuing currency pairs is an imprecise process. Rather than the illusory precision of a point- estimate for
fair value, we calculate HSBC Little Mac Valuation Ranges for many currency pairs. If the current price is
a long way from this valuation range then we interpret this as being a significant valuation signal.
However, for currency pairs where the price is within, or very close to, this valuation range, then we view
it as too close to call.
Valuing currency pairs
Assets that generate a stream of future cash flows can be valued by discounting these expected cash flows with
an appropriate discount rate. Currencies, however, generate no such cash flows so an equivalent valuation
procedure is not possible. FX valuation methods are typically based upon the principle of purchasing power
parity (PPP). This rather technical-sounding term really just means that similar baskets of goods and services
should not cost wildly different amounts in different countries.
When large deviations from PPP are found, it is usually assumed that the adjustment back to PPP will come
mostly from a changing exchange rate. This is because exchange rates are more flexible than the prices of goods
and services. However, it is important to remember that the currency valuation result is ultimately derived from
a discrepancy between the prices of goods and services. Any observed valuation signal can be corrected by a
sustained inflation differential rather than by the exchange rate moving.
Long-term planning assumptions
We normally publish FX forecasts with about an 18-24 month time horizon. The purpose of these forecasts
is to give customers a very shorthand way of identifying where we see the principal risks in the FX market
over the next year or so. As always, we would caution against taking point forecasts too seriously. They
are only designed to show what we see as the principal directional risk for a currency pair, and whether we
expect the price to move a little or a lot. Long experience has shown us that when we are basically right on
market direction, the market moves further and more quickly than we dare forecast, and one-year targets
can be reached very quickly. When we have the direction wrong, we can be wrong for a very long time.
Given the problems of forecasting out one year, many are understandably reluctant to venture a view for
further out. However, we are aware that a number of our clients have a need for some indication of the
likely FX market direction over a longer-term horizon for planning purposes. So, with some trepidation,
we publish longer-term forecasts. If our one-year forecasts need to be treated with caution, it goes without
saying that the longer-term numbers should be used with even greater care. Nevertheless, we are aware that
decisions and plans have to be made, and that a defensible set of forecasts may be of some value.
Methodology
The long-term forecasts are based upon the following methodology:
1. Short-term forecasts to the end of 2021 are taken from our existing numbers
2. We use a PPP-based approach to estimate a long-term ‘fair value’ for the exchange rate. For more
details on PPP and currency valuation please see HSBC Little Mac Valuation Ranges (9 September
2015).
3. We assume a gradual convergence to this long-term ‘equilibrium’ level. We assume that the spot rate
will converge to our fair value estimate, from the level of our end-2020 forecast, with a convergence
half-life of five years. This means that by the end of our long-term forecast period (end-2025) the
exchange rate will have moved half way between the
end-2020 forecast and ‘fair value’.
Long-term forecasts
End-2021f 2022f 2023f 2024f 2025f 2026f
EUR-USD
GBP-USD
USD-JPY 105 104 104 103 103 103
AUD-USD
NZD-USD
USD-CAD
USD-CHF
USD-NOK
USD-SEK
USD-CNY
USD-IDR 14200 14156 14118 14084 14055 14030
USD-INR
USD-SGD
USD-THB
USD-TWD
USD-KRW 1210 1196 1184 1174 1165 1157
USD-MYR
USD-PHP
EUR-CZK
EUR-HUF 345 343 341 339 338 336
EUR-PLN
USD-ILS
USD-RUB
USD-TRY
USD-ZAR
USD-ARS* 100 120 135 150 170 180
USD-BRL
USD-CLP 750 737 725 715 707 699
USD-COP 3300 3253 3213 3178 3147 3120
USD-MXN
USD-PEN
*As there are no HSBC Little Mac Valuation Ranges for USD-ARS, the long-term forecasts were produced by the LatAm
FX strategy team Source: HSBC forecasts
G10 at a glance
EUR-USD Eurozone: Economic woes
EUR-USD is currently trading close to our year-end forecast
of . We believe the USD will remain resilient,
despite consensus still looking for EUR-USD to
move higher.
We fail to see the EUR rebounding until there are clear
signs of economic recovery. The ever-more-limited
room for
monetary policy easing is likely to remain a negative
factor for the currency. If recent easing fails to deliver
significantly higher inflation or growth, then it would
seem that monetary policy would have run out of steam.
At that point, a weaker currency may be the only way to
deliver looser financial conditions in the Eurozone. The
ECB has recently launched a “strategic review” of its
monetary policy, which is due to be ongoing throughout
2020.
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
There is the possibility that the US administration
increases its focus on targeting European exporters. An
increase in tariffs on
EU goods moving to the US would be EUR negative.
Source: HSBC, Bloomberg
JPY-USD Japan: The safe house
130 130 We see USD-JPY at 105 by year-end. The JPY continues
to retain its ‘safe-haven’ status, dominated by global
developments
120
110
100
90
80
70
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
12
0
11
0
10
0
90
80
70
as the local story takes a back-seat. In our view there is
room for the JPY to strengthen, as the outlook for global
growth appears to have softened already in 2020.
Indeed, in the most recent risk-off environment cultivated
by the coronavirus outbreak, JPY-USD has shown an
even more negative correlation with the S&P 500 than in
the “peak RORO” period of 2012 (see RORO rotation
reveals relative value).
On the domestic front, Japan’s government has recently
nominated Seiji Adachi – a known ‘dove’ and
‘reflationist’– to the board of the BoJ, reported as a
signal that Prime Minister Abe does not intend to back
down from his stimulus programme. This comes at a
time when the BoJ is balancing upholding inflation
expectations and financial stability (see
Source: HSBC,
Bloomberg
Bank of Japan, 21 January).
USD-CAD Canada: Caught in headwinds
The CAD has weakened notably so far in 2020. This
reflects the CAD’s exposure to the decline in risk
appetite prompted
by concerns about coronavirus outbreak. While there is
still a lot of uncertainty about the potency and duration
of the damage to global economic activity, the
direction for now is clear. The CAD has also been hit
by the sharp drop in oil prices which have fully
reversed the rally seen during Q4 19. We expect the
weakness in the CAD to persist due in part to the
fragility of risk appetite.
However, we also think that factors particular to
Canada will continue to put the CAD under selling
pressure. The BoC, at
its January meeting, chose to characterise the soft
data during Q4 19 as likely to be temporary in
nature.
We believe some of the weakness in activity may be
more persistent, especially with the additional
headwinds from the
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
Source: HSBC, Bloomberg
0
coronavirus. Even before the outbreak, data has long
shown Canada’s non-energy export sector is not
growing.
Employment growth is also slowing and we remain
nervous about the vulnerability of the household
sector to the rate hikes already in place. We continue
to look for USD-CAD to finish the year at .
Asia – regional overview
Many Asian currencies have weakened since the coronavirus outbreak started gripping the FX market’s
attention just before the Lunar New Year holiday. The SGD and THB have depreciated the most, followed by
the KRW, MYR and RMB. In contrast, the TWD has been resilient alongside the INR, IDR and PHP. In our
view, the relative performance of Asian currencies over the past month accurately reflects the potential
economic impact of the virus outbreak on their respective economies (directly via tourism and indirectly via a
slowdown in mainland China’s growth – see charts below), while taking into account local idiosyncrasies and
flush global liquidity conditions (supporting the high-yielding currencies, in particular). We expect this relative
FX performance to prevail until the virus outbreak becomes more contained.
There have been some local developments in certain currencies that exacerbated the negative implications of the virus
outbreak. The sharp depreciation of the SGD not only reflects the market’s assessment that the economic impact on
the small and open Singapore economy could be especially significant, but was also due to the Monetary Authority of
Singapore’s (MAS) unusual comment on 5 February that basically provided tacit approval for a weaker SGD NEER
(see Asian FX Focus: Easing on the sly, 10 February). FX forward points suggest to us that the market now sees a
roughly 70% probability that the MAS will adopt a 0% slope soon, as opposed to a roughly 20% probability at the
start of the year.
Similarly, notwithstanding the THB’s weakness, policymakers in Thailand signalled that they remain committed to
further correct the THB’s overvaluation (see Asian FX Focus: 2019 hindsight is 2020 vision, 3 February 2020). The
Bank of Thailand (BoT) said on 6 February, after cutting the policy interest rate to a record low, that it will continue to
roll out capital account liberalisation measures (to basically allow residents to invest abroad more freely and in greater
amounts). Indeed, on 7 February, the Ministry of Finance announced a tweak to an exports repatriation rule that was
first relaxed on 8 November: exporters will now be allowed to keep up to USD1m per lading bill offshore, up from the
previous limit of USD200,000. We also note that the BoT’s FX reserves have been rising every week since late
December.
On the other hand, there are some local idiosyncrasies that partially mitigated the negative implications of the
virus outbreak. One example of such an offsetting factor is mainland China’s shrinking tourism trade deficit.
That typically amounts to USD18bn or so per month, which is about half of the goods trade surplus. The
RMB’s resilience so far is probably partly because such an
important source of net FX demand onshore has basically disappeared temporarily. Another example is the “re-
shoring” (reversal of offshoring) of investments and production in Taiwan since last year (see Asian FX Focus:
TWD: Shored by “re-shoring”, 8 October 2019), which has contributed to a “decoupling” of the TWD and
RMB.
1. Contribution of international tourism
revenue to nominal GDP
2. Value-added (real GDP) sourced from
mainland China’s final demand
14%
12%
10%
8%
6%
4%
2%
0%
VND THB MYR SGD PHP TWD IDR
KRW INR
International tourism revenue in 2002
International tourism revenue from other tourists in
2019 Tourism revenue from mainland Chinese
tourists in 2019
14%
12%
10%
8%
6%
4%
2%
0%
% of source country's value-added that is exposed to...
TWD HKD MYR SGD KRW THB VND PHP IDR INR
Mainland China's final demand in 2015 In 2005
Source: CEIC, HSBC Source: OECD TiVA, HSBC
%
GDP
Asia at a glance
USD-CNY China: Limited downside to RMB
USD-RMB rebounded to around on concerns
over slower growth with the coronavirus outbreak.
However, we
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
8.
5
8.
0
7.
5
7.
0
6.
5
6.
0
think further upside risks are limited due to policy
responses and persistent Northbound Stock Connect
inflows.
Furthermore, we believe local exporters are under-
hedged, and some of them may take advantage of the
recent move higher in USD-RMB to sell their excess
USD. FX demand from importers could also be lower
than usual due to the sharp drop in commodity prices
and delays in industrial production. And, importantly,
the decline in outbound travel should reduce locals’ FX
demand up to USD15-20bn a month.
Nevertheless, we acknowledge that there is upside risk
to our end-March forecast of for USD-RMB if the
uncertainty persists. But so far the currency’s
performance also suggests there is no rush of outflows
among locals, and the trend of long term asset
allocation into mainland China remains intact. Our
year-end forecast is . This is consistent with the
tariff reduction laid out in the ‘Phase 1’ deal.
Source: HSBC, Bloomberg
USD-INR India: Staying the course
USD-INR has been supported by the government’s
decision on 1 February to target a wider fiscal deficit
of % of GDP
78 78
73 73
68 68
63 63
58 58
53 53
48 48
43 43
38 38
05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
for FY21. The budget may not lead to higher capital
inflows, in our view. There have been of
equity inflows but USD1bn of bond outflows, year-to-
date. Changes related to foreign investments in
corporate bonds and allowing full access for non-
resident Indians in certain government securities may
not change investors’ sentiment for the better.
Meanwhile, FX swap curves (both onshore and
offshore) bull flattened following the RBI’s surprise
decision on 6 February to conduct Long Term Repo
Operations of one-year and three-year tenors for a
total amount of exceeds the surplus
INR liquidity ( YTD) in the banking
system. The short-end of the FX swap curve is
restrained by higher inflation expectations. The RBI
raised its inflation forecasts to % for 1H of FY21
(from %), closing in on the policy rate at %.
See India Budget 2020: Hinging on execution… and
some luck, 2 February 2020
Source: HSBC, Bloomberg
USD-IDR Indonesia: Rally running out of steam
The IDR outperformed in the region as sentiment
towards Indonesian assets remains fairly positive.
Bank Indonesia
16000
15000
14000
13000
12000
11000
10000
9000
8000
05 06
07 08
09 10
11 12
13 14
15 16
17 18
19 20
16000
15000
14000
13000
12000
11000
10000
9000
8000
ource: ce: HSBC,
Bloomberg
(BI) is still two
more cuts away
from the end of
the cycle. In the
2017 easing
cycle, USD-
IDR did not
actually rise
until BI
delivered the
last cut in
September.
But we think
USD-IDR has
found near-term
support at
around 13600.
The currency is
also getting
expensive –
both its nominal
and real
exchange rates
are approaching
the highs
reached during
the end of 2016.
As such BI
prudently
boosted FX
reserves by
in
January,
absorbing
inflows from
the sovereign
debt issuance.
The IDRs gains
should also be
halted by the
loss of tourism
related inflows.
Indonesia’s
tourism
industry
collects about
USD20bn a
year from
foreigners, with
Chinese
tourists
accounting for
13% of that.
And Indonesia
may also be
negatively
affected by
lower prices for
some of its
commodity
exports (palm
oil, coal). The
revenue loss is
only partially
offset by lower
oil import
costs.
USD-KRW South Korea: Back to watching 1,200
USD-KRW rose to near 1,200 recently and the Korean
authorities engaged in verbal intervention – for
example, the
1600
1500
1400
1300
1200
1100
1000
900
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
160
0
150
0
140
0
130
0
120
0
110
0
100
0
900
MoF said that it will sternly deal with FX speculation
(Source: Bloomberg, 3 February). That slowed the
rise of USD-KRW subsequently, although we think
1,200 may not be a real line in the sand.
We think the authorities will smooth any rapid
movements in the exchange rate, but they are probably
not particularly attached to specific USD-KRW levels.
Recall that the 1,200 level held in May 2019, but
broke in August last year. And in both months, FX
reserves fell by a similar amount of around ,
as per balance-of-payments data.
There are other things to consider, too. First, USD-
RMB has rebounded from a mid-January low of
to near the level due to the coronavirus concern.
Second, spot DRAM prices surged by 20% between
early December and mid- January but have since
plateaued. In our view, it will be concerning if prices
start to retrace.
Source: HSBC, Bloomberg
USD-SGD Singapore: Easing on the sly
The MAS issued an unusual statement on 5 February. This
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
5
5
5
5
5
5
5
is how we interpret its words: the economy will likely
weaken in the coming months and while the MAS has
not decided at this juncture if a 0% slope is necessary,
a decline of the SGD NEER within the band would be
helpful to deliver an effective easing of monetary
conditions. The SGD NEER fell to the midpoint in our
model after the statement.
In our view, the MAS may think that the economic
impact of the virus outbreak could turn out to be
short-lived and is probably best dealt with using fiscal
policy which is timelier and targeted.
We think the SGD NEER may consolidate around the
midpoint in the near-term as investors assess incoming
data on growth, inflation and FX reserves. But if a 0%
slope looks likely later, the index could fall to %-
1% below the midpoint. See Asian FX Focus: SGD:
Easing on the sly, 10 February 2020.
Source: HSBC, Bloomberg
USD-TWD Thailand: BoT pacing itself for a marathon
The BoT cut rates to a record low of 1% on 5
February, but did not announce any of the FX-related
deregulatory
35 35
34 34
33 33
32 32
31 31
30 30
29 29
28 28
05 06 07 08 09 10 11 12 13 14 15 16 17
18 19 20
measures that the governor had earlier hinted about. This was
probably because the THB NEER is already down by around 4%
from October 2019, especially after the coronavirus outbreak in
late January (tourism is an important industry for Thailand). But
the BoT said that it will not be complacent about the THB's
correction, since the currency is still overvalued, and it will
continue with capital account liberalization.
In our view, the BoT is being prudent by pacing itself with the
various policy actions that could potentially induce
THB depreciation. It has limited policy room to
manoeuvre, be it with interest rate cuts, reduction to
bill/bond issuance, curbs on foreigners’ positioning,
and USD-buying FX intervention. It would be more
opportune to roll out the FX deregulatory measures if
the THB starts to recover later.
See Bank of Thailand: A new record low, 5 February 2020.
Source: HSBC, Bloomberg
LatAm – regional overview
We believe that the challenging external environment together with excess market liquidity have supported better
performance from higher yielding currencies like MXN in recent weeks. Indeed, while we have seen some
positive developments in Mexico to start 2020, such as USMCA ratification in the US, the main driver for why
USD-MXN has traded in such a tight range recently has been MXN’s volatility-adjusted carry. This may
continue through 1H 2020 in our view, though the erosion of the real rate buffer, soft growth dynamics and a
weak fiscal trajectory may start to weigh on MXN in the latter part of 2H 2020.
Conversely, the BRL’s low carry has not been enough to compensate investors for the risk, with the Selic
target rate having been reduced from % back in 2016 to % as of February 2020.
Coming into this year, we thought Brazil was one of the few EM countries that could structurally offer some
positive economic growth, but the outbreak in China along with some weaker macroeconomic data on industrial
production and retail sales took the shine off those expectations. Moreover, a widening current account,
declining terms of trade and lacklustre investment flows have kept the BRL under downward pressure. We still
think Brazil can see stronger growth ahead, but we adjust our year-end USD-BRL forecast up to from
previously.
Political risks have calmed down somewhat in the region, due in part to the summer holidays. In Peru, the
Congressional elections on 26 January had very little effect on PEN performance as the results indicated that the
country will have a more fractured congress, which may lessen opposition to the president’s political reform
agenda. On the other hand, there are no clear signs yet of the unrest and political tension in Chile going away.
There are several (potential) event risks in March, as (1) university students return to school, (2) campaigning on
the 26 April constitutional referendum begins, (3) the central bank will update its monetary policy guidance in
its quarterly inflation report and (4) the government will provide new fiscal projections. Colombia has also had
its share of protests in January, but we think the nature of these have been different from the ones affecting
Chile (shorter lasting and more structured via unions), thus limiting the impact on COP so far.
Finally, in Argentina, FX controls and tight FX management mean the ARS's path will likely be determined by the
authorities’ policy decisions. We believe the central bank has begun moving to a crawling peg policy in an effort to
relax some of the pressure building in the FX system and real appreciation of the ARS. As of mid-January, we have
seen ARS depreciate in nominal terms with BCRA lowering its interest rate floor from 63% in December to 48% in
early February. We believe USD-ARS will move higher through 2020 to end the year at , though the path to
get there is uncertain.
Latin America at a glance
USD-BRL Brazil: A disappointing start to the year
It is becoming clear that investors want yield
protection for any EM FX risks they will be willing
to take, and Brazil no
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
4.
5
4.
0
3.
5
3.
0
2.
5
2.
0
1.
5
longer offers it. The benchmark Selic rate has been
cut to % and now that the central bank has
indicated rate cuts will be paused, the duration trade
may be over. This leaves little incentive for
investors to buy the BRL unless we see more
concrete signs of growth.
Household credit is picking up and consumption with
it, but this will see imports rise and the current
account deficit widen. FDI will still finance the gap,
but with declining terms of trade and recent
industrial production data disappointing, investors
are wary.
We think an active cyclical recovery in Brazil is still
possible, but the virus outbreak may crimp the 1Q
growth figure. For now, we still give Brazil the
benefit of the doubt on the anticipated growth
rebound, but we adjust our year- end USD-BRL
forecast up to from previously.
Source: HSBC, Bloomberg
USD-MXN Mexico: Carry still prevails
Excess liquidity in the market continues to
encourage demand for yield, particularly in an
increasingly difficult external environment. MXN
stands out because it
22 22
21 21
20 20
19 19
18 18
17 17
16 16
15 15
14 14
13 13
12 12
11 11
10 10
9 9
05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
pays 65bps of volatility-adjusted carry
annualized, and from the outset, Mexico has
reduced its current account deficit and the
government maintains a conservative fiscal
stance.
However, we believe the fundamental picture looks
less attractive than the top line numbers suggest. For
example, the current account deficit narrowed but
only because imports declined sharply, mainly in the
capital and intermediate goods categories. We also
expect government expenditures to rise this year
while revenues will be stable to lower.
We believe the MXN can remain range-bound in
1H20 due to its high carry but think the currency
could weaken later in 2H20 as we think the real rate
buffer will be eroded, the economy will remain soft
and fiscal dynamics can start to be impaired.
Source: HSBC, Bloomberg
USD-CLP Chile: Watch out for event risks
We expect an increased level of scrutiny on Chile in March,
850
800
750
700
650
600
550
500
450
400
05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
850
800
750
700
650
600
550
500
450
400
as (1) university students
return from summer
holidays, (2) campaigning
on the 26 April
constitutional referendum
begins,
(3)the central bank will
update its monetary policy
guidance in its quarterly
inflation report and (4) the
government will provide
new fiscal projections.
Moreover, copper prices
have fallen significantly
since the coronavirus
outbreak, and the CLP vs
copper correlation has
been rising.
We expect CLP to
remain weak in
1H20, due to poor
external risk
sentiment and its
exposure to potential
political uncertainty.
However, the currency
looks cheap in real terms
compared to its 10-year
average and relative to
its terms of trade. If
market conditions
stabilise, then we think
USD-CLP levels can
retrace lower in 2H20 to
around 760 in line with
our estimate of fair value.
Source: HSBC, Bloomberg
CEEMEA – regional overview
High-yielders feel the pressure
The uncertainty surrounding the impact of the China slowdown on EM economies has transpired in the
CEEMEA FX space. The high-yielders have been on the front line. The RUB has been negatively impacted via
the commodity channel, whilst the ZAR weakness is the result of renewed downside risks to an ailing economy
and increasing fiscal challenges. We believe that the move up in
USD-ZAR is consistent with the return of risk on – risk off (RORO) type of price action. The ZAR depreciation
could become more idiosyncratic in coming weeks with the presentation of the budget on 26 February.
However, our analysis in RORO rotation reveals relative value (5 February 2020) shows that the RUB had
overreacted to the RORO factor. Therefore, we believe that recent RUB weakness will not last and that the
currency should resume its appreciation trend. The macro fundamentals and the dynamic of real rates remain
supportive for the currency. The central bank is in the rate cut cycle but the loosening is consistent with the rapid
deceleration of inflation, which has moved well below the medium-term objective of 4%. Moreover, at the
current juncture, the compression of nominal rates does not prevent real rates from actually rising.
The TRY remains a special case as it has not displayed a great sensitivity to global factors over the recent
weeks. Yet, on 9 February policymakers have tightened regulations to avoid more acute currency weakness.
The backdrop is fast-changing but we believe it is necessary to look through the noise and pay attention to the
fundamentals.
We see three reasons why the TRY is less vulnerable to sharp weakness than in the past:
1) dollarization is already high, 2) external financing needs are sizeable but less adverse than last year, 3)
foreign engagement in the local market is very low. Therefore, we see only a modest TRY deprecation in 2020.
The biggest risk factor for the currency is persistently negative real rates. Real rates have fallen significantly as
the CBRT has cut rates aggressively. For now, this has not had too much of a negative impact on the TRY. Now
much depends on whether the CBRT is correct in its assessment of where real rates will move, given their
forecast is for inflation to fall towards 8%. If the CBRT is incorrect and inflation picks up more markedly, then
the TRY would be at greater risk, particularly from a rebound in local demand for FX.
1. Dollarisation phenomenon stabilised in
recent months in Turkey
USDbn Residents' FX deposits
USDbn
2. Foreigners have significantly reduced their
exposure to the Turkish bond market
USD bn % of Debt (rhs)
190
180
170
160
150
140
130
120
110
100
190 60 28
180
50
26
170 24
160 40 22
150 30
20
140 18
130 20 16
120 10
14
110 12
100 0 10
Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18Jan-
19Jan-20
2013 2014 2015 2016 2017 2018 2019 2020
Source: HSBC, CBRT Source: HSBC, Ministry of Finance, CBRT
CEEMEA at a glance
EUR-PLN Poland: Reflation rewind
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
5.
0
4.
6
4.
2
3.
8
3.
4
3.
0
The PLN has been surprisingly resilient so far. We
believe that the currency should weaken in the months
ahead, and underperform its CEE peers. The PLN
benefitted from signs of a “reflation trade” early in the
year, but we believe this could become more of a
problem for the currency.
Inflation has been rising sharply and may not have
peaked yet. This, alongside a central bank with little
desire to hike policy rates, is pushing the real rate
deeper into negative territory. In fact, one could even
call the NBP dovish with the Governor suggesting that
a rate cut is a higher possibility than a rate hike. The
board largely sees inflationary pressures as temporary
and may be more concerned about the deceleration of
growth.
We see EUR-PLN moving to this year.
Source: HSBC, Bloomberg
EUR-HUF Hungary: Time to bounce on Bubor
While we retain a structurally bearish view on the HUF,
we do not think that EUR-HUF should rise as much as
EUR-PLN,
360
340
320
300
280
260
240
220
05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 20
36
0
34
0
32
0
30
0
28
0
26
0
24
0
22
0
for example.
While the overall policy framework remains loose, there
has been a clear tightening of liquidity conditions by
the NBH. In the last month, 3m Bubor has risen to
%. This may not seem that big, but in the context of
rates starting at such low levels and given such low rate
volatility in recent years, this move should not be
ignored. Indeed, the last time Bubor rose in a similar
fashion, in mid-2018, the HUF followed suit. EUR-
HUF fell about 3% from 330 towards 320.
This time around, the NBH has avoided explicit
language about tightening so the announcement effect
is not there for EUR-HUF. But the FX market should
not ignore the simple fact that rates are going up and
there is a tightening of liquidity conditions, which
should help HUF relative to PLN.
Source: HSBC, Bloomberg
EUR-CZK Czech Republic: Chequered flag in sight
The CZK rallied after the CNB unexpectedly hiked rates by
31 31
30 30
29 29
28 28
27 27
26 26
25 25
24 24
23 23
22 22
05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
25bp to %. But how long this FX strength can
endure is more questionable. The combination of
higher rates and a stronger currency are already
causing a de facto “double tightening” of monetary
conditions. The simple fact that rates are now higher
should continue to provide some relative support for
the CZK, versus the PLN and HUF.
But questions are likely to re-emerge over the
circularity between FX and rates. Should EUR-CZK
stay below the CNB’s central projections – its Q2
forecast is – then it might limit the central
bank's ability to stay hawkish.
In our view, this circularity should constrain excessive
CZK gains. Meanwhile, the CNB’s latest Pribor
forecasts suggest that they have reached the “terminal
rate” in this cycle. This should prevent EUR-CZK
falling much lower from here.
Source: HSBC, Bloomberg
HSBC Volume-Weighted REERs
For full details of the construction methodology of the HSBC REERs, please see “HSBC’s New Volume-
Weighted REERs” Currency Outlook April 2009.
The value of a currency
Since FX prices are always given as the amount of one currency that can be bought with another, the inherent
value of a currency is not defined. For example, if EUR-USD goes up, this could be because the EUR has
increased in value, the USD has decreased in value, or a combination of both. One possible method for getting
some insight into changes in the value of a currency is to look at movements in the value of a basket of other
currencies against the currency of interest. For example, if EUR-USD increased over some time period, one
could see how EUR
