The US dollar

In currency markets, the strength of the US economy continues to underpin the stretched valuation of the US dollar (USD), a theme that has persisted for years.

A window for USD weakness appears likely to open as the Fed’s easing cycle approaches, but it’s likely to prove limited, with the US election later in the year a potential major source of uncertainty. A second Trump presidency has the potential for major trade disruption given it is likely to usher in a new era of trade protectionism.

In our view, the fact that house prices have held up much better than expected is a meaningful factor that will make central banks reluctant to cut rates as rapidly as markets expect.

The Alpha View – How to position in the currency space

In our view, short-to-medium-term currency movements are driven by a combination of alternative risk premia (Alt Risk Premia) and macro fundamentals. Our macro investment process suggests there is a window of opportunity for the USD to weaken. This is especially so versus the Japanese yen (JPY) where the expected monetary policy divergence is the greatest.

However, the risk premia factors remain supportive for the USD. As such, our overall preference remains to be moderately long USD.

We are also moderately constructive on the British pound (GBP), New Zealand dollar (NZD), and Norwegian krone (NOK) and to a smaller extent the Australian dollar (AUD). Against that, we prefer short positions in low-yielding currencies such as the Swiss franc (CHF) and the JPY.

Longer-term valuation overview

Currencies that look overvalued, undervalued or fair valued:

• The USD remains overvalued, but not against all crosses.

• The JPY and Swedish krona (SEK) look very cheap by historical

• standards.

• The euro (EUR), AUD and NOK look moderately cheap.

• The GBP, CHF, and NZD are close to fair value.

You can access Insight Investment’s full Currency Quarterly here.