The global coronavirus pandemic has impacted forex market performance, with many smaller currencies outperforming the more liquid ones.
Prior to the COVID-19 outbreak, Brexit and the trade war between the U.S. and China determined FX performance.
“Before the COVID-19 outbreak, traditional drivers of currencies were working badly. In times of increased optimism about the global economy, smaller currencies outperform more liquid currencies with defensive qualities, and vice versa when pessimism dominates,” Richard Falkenhäll, senior FX strategist at SEB, says in a note.
Daily or weekly changes in exchange rates are seemingly on the decline as a result of synchronised monetary policy, financial market regulations and very small differences between countries, the strategist says.
2020 FX Outlook: Falkenhäll forecasts exchange rates over the next six to 12 months will depend primarily on the global growth outlook and changes in risk appetite.
The smaller and undervalued currencies will have the chance to outperform major currencies, and the U.S. dollar is likely to be among the weakest, he says.
The Japanese yen is undervalued against the U.S. dollar, and it would be reasonable to see it strengthening now, the strategist says.
Below are SEB’s FX projections for the coming months.
EUR/GBP: The upside risks dominate without a Brexit deal, according to SEB.
“Time is running out and negotiations on a new trade deal with the EU have not moved forward since the COVID-19 outbreak in February 2020. There are no signs the U.K. would opt for an extension of the withdrawal period to get more time and this will weigh on the GBP short-term.”
The Bank of England is exploring the possibility of negative rates, the strategist says, adding that the pound is already undervalued and should recover as risks fade.
EUR/USD: SEB sees mounting upside risks here.
“After the U.S. Fed rate cuts earlier this year, the carry is not a tailwind anymore. Continued large U.S. twin deficits may lead euro investors to increase their Treasury holdings again, putting marginal upward pressure on the dollar. However, improving risk appetite and the fiscal expansion from Germany, as well as the EU long-term budget together with the EU Recovery Instrument, should attract capital from safe dollar assets into Europe and drive the EUR/USD higher this year.”
USD/JPY: JPY is undervalued, but it will fall anyway, according to SEB.
“The JPY is undervalued against the USD, and it would be reasonable to see it strengthening now. However, its status as a defensive currency will attract capital outflows if the global situation continues to improve. We expect it to follow the USD lower over the next 6-12 months.”
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