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Judith J. Francis

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Published on: 24 Mar 2017 by francisjud

Capital group emerging market tokyo japan: Global Currencies Outlook, The Strong Dollar Is Losing Steam

Currency movements often produce a wild ride for
investors, but 2016 was a year for the ages. The pound sterling tumbled to a
30-year low, the euro declined sharply in the fourth quarter, and the U.S.
dollar staged a remarkable bull run.

                   

What’s
in store for 2017? In my view, the roller coaster won’t stop, but the ride
should be less bumpy. That’s important because currency fluctuations can have a
big impact on investment results. In 2016, for instance, European stocks
enjoyed a robust 7% gain in local currency terms. But for dollar-based
investors, currency movements eliminated all of those gains, producing a loss
of –0.4%.

 

Here
are my thoughts on the outlook for select global currencies this year:

 

U.S. Dollar Nearing a Peak

 

A
strong acceleration in U.S. economic growth — perhaps influenced by the
policies of the new U.S. president — could drive the dollar a bit higher, but
probably not by more than 5% or so. The dollar is on the last legs of a
multiyear bull run, in my opinion, after rising more than 30% since 2011.
Calling a peak is always difficult, but it’s obvious that a lot of good news on
the U.S. economy is already baked in to the current dollar price. The dollar is
overvalued by about 10%, in my estimation, so there are limits to how much
further this bull can run. I think the dollar entering a consolidation phase
this year would not be surprising.

 

Euro Recovery on the Horizon

 

If
one accepts the premise that the dollar is expensive, then that means some
other currencies are undervalued. The euro has been cheap for several years, in
my view, but the stage is set for a recovery. Growth in the euro-area economy
is starting to firm up. And inflation is beginning to rise, albeit from very
low, deflationary levels. If these trends continue, then the European Central
Bank is likely to start reducing its bond-buying program, which should allow
the euro to appreciate. However, I think this won’t happen until the second
half of 2017, after the French and German elections. Once the political
uncertainty declines, the euro will be in a good position to rise.

 

Pound Sterling Bottoming Out

 

There
is still a high degree of uncertainty surrounding the U.K.’s departure from the
European Union, a process that is expected to take two years. The current value
of the pound, which is down 15% against the dollar since last summer, already
incorporates some “hard Brexit” risks. As long as this uncertainty continues,
there isn’t much reason for the pound to move a lot higher, but I also don’t
see it falling much more from here. The pound’s valuation is attractive today,
but there is little reason to be optimistic until we know how the U.K. will be
treated outside the EU.

 

Yen Remains Undervalued for Now

 

The
yen experienced a true roller-coaster ride in 2016, essentially making a round
trip and ending up close to where it started. The yen’s valuation is cheap, but
it is trading at such levels due to the Bank
of Japan’s
very aggressive asset purchase program, combined with yield
curve control measures. Given the upward pressure on global interest rates, the
risk is that markets will test the central bank’s ability to keep Japanese
interest rates low. Any sign that the BOJ’s willingness and ability to keep rates
low is fading will quickly trigger a stronger yen.

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