2020 FX Outlook: Diamonds in the rough

• Diamonds in the rough? Definition: ‘something with hidden characteristics and future potential’. In an FX market priced for secular stagnation, we think the call for 2020 is to identify those undervalued currencies able to hold their own against the dollar – but which are also backed by both yield and growth.
• Screening for these characteristics we find that commodity currencies should perform well in 2020. In the G10 space, we like the currencies of Norway, Canada and New Zealand. In the EM space, BRL may offer one of the best stories in 2020.
• What of the dollar? Unlike many others, we don’t see a clean dollar bear trend in 2020. Continued money printing from G3 central banks means relatively subdued ranges for G3 currencies, with the EUR emerging as the funding currency of choice.

Key views
Second-guessing the mutually acceptable deal scenarios for Presidents Trump and Xi has proved a near-impossible task in 2019. And overlaying a 2020 FX outlook on a single baseline scenario looks dangerous. Instead we are taking the view that: (1) world trade volumes are unlikely to fall as sharply as they have over the past two years; and (2) some segments of the FX universe are already priced for a view of secular stagnation.

Developments in core markets will also define the 2020 outlook. G3 economies look set to slow further, G3 central bank balance sheets could grow by as much as US$1tr and core bond yields will remain subdued. Renewed liquidity should keep volatility low.
Outperforming in this environment should be those undervalued currencies, with yield, that can deliver total returns against the dollar. Relative economic strength should help too. In the G10 space, this favours NOK, CAD and NZD as well.

In this publication, we make the case for a different kind of dollar decline. One played out against selective commodity currencies and high yielders, rather than a broad-based drop. There are no clear signs of the de-dollarization trend hitting escape velocity yet, but we have an article on whether Central Bank Digital Currencies (CBDC) can play a role in the huge cross-border remittance market. This could reduce dollar demand.

We also present a dollar scenario analysis around US Presidential elections in November.

Subdued growth in Europe suggests investors will have to work hard for returns here. We are edging our EUR/USD forecast lower (1.13 by end-2020) on the view that the EUR is emerging as a useful funding currency. GBP may enjoy a brief rally should the Tories win a working majority and start to ‘get Brexit done’, but uncertainty over the transition period will limit gains. EUR/GBP is thus unlikely to dip much below the 0.82/0.83 area.

In EMEA, the slowdown in Western Europe is starting to weigh on the CEE. However, the Czech national bank looks set to push ahead with a hike and we favour CZK outperformance amongst CE4 (mainly versus HUF). Elsewhere the rouble should holds its gains through 1Q20.

The vagaries of the trade war have made Asian FX a particularly difficult story. Asian FX underperformance has been compounded by the electronic cycle, where high inventory levels and delays in 5G roll-outs have hit some of the key players hard. However, all currencies (barring THB) look undervalued and if it’s a big if, trade tensions do not get dramatically worse, high beta currencies like CNY and KRW can recover.

In the Latam space, the 2020 story should be one of a reversal of fortunes. The high yield MXN may stand to lose its armour if Banxico embarks on an independent easing cycle. And, after a tough year, we’re looking for a recovery in BRL. After worthwhile fiscal reforms this year and as growth picks up, a re-rating story should see notable BRL gains – more likely to be seen after Argentina has restructured its debt in March 2020.

**Please note that this is the non-investment research version of 2020 FX Outlook and does not include the investment strategies contained in the Global Markets Research version of this report**