Aegon AM: 2024 currency outlook

December 7, 2023

Gareth Gettinby, Investment Manager at Aegon Asset Management, has published his 2024 currency outlook. He reflects on past performance of the big currencies to create future scenarios and talks about the economic impact of central banks in enforcing their monetary policy, specifically the Bank of Japan (BoJ) and the Bank of England.

The strength of the US Dollar will remain persistent heading into 2024 helped by soft global growth and relatively high US yields. As interest rates are being passed through faster in other major economies than in the US, the Fed will stay relatively higher for longer.

For the dollar to weaken it will require better growth in Europe and China, along with continued disinflation. There would also need to be a dovish pivot and for the Fed to be aggressively cutting more than elsewhere; this will only happen if there is a tail event or a US recession, neither of which is our base case.

Sterling, however, looks less positive. We do not expect a repeat of last year’s outperformance. The outlook for the UK has deteriorated again as the economy and consumer begin to feel the impact of 14 consecutive interest rates increases (to 5.25%), leaving interest rates at the highest since the financial crisis.

Whilst a lot of the weak structural backdrop is known, the key negative for GBP over 2024 is the potential for the markets to price in earlier rate cuts. Sterling will now return to trading by conventional metrics such as global risk and rates.

Continued stability is likely as good as it will get for the euro; it is difficult to envisage a rebound as the region struggles for growth momentum. There are signs that weak demand is spilling into a softer labour market. There will also be limited fiscal support from many governments with Italy, France and Spain all constrained by having debt to GDP greater than 100%.

For the euro to rally the drivers will need to come from abroad. A rebound in China growth, from policy stimulus would benefit the Euro area through a positive shift in regional growth and a cyclical upturn. Another, but less likely driver would be the US Federal Reserve’s easing policy rates more quickly than anticipated, thereby reducing the real rate differential, and supporting the euro.

Without significant cuts by the US Federal Reserve and a proper hiking cycle by the Bank of Japan, there may be limited appetite for the yen which, impacted by higher US yields, fell to a 32 year low against the US dollar. The carry trade (difference in interest rates between two countries) was important last year as investors used JPY as a funding currency given the negative interest rates in Japan.

Investors are now significantly underweight JPY so unwinding those currency carry trades would see JPY strengthen sharply but it requires growing concerns about a US recession, leading to lower risk asset prices and lower US government bond.

Emerging markets may continue to present opportunities. In a friendly macro background where US yields decline slowly, high yielding Latin American should continue to offer attractive carry. Whilst they no longer look cheap, a number of them (MXN, BRL) have strong fundamentals and attractive cyclical and commodity exposure. In Asia FX, much will depend on any recovery in China. It is likely the PBOC will tolerate a weak currency to support an economy struggling to contain deflationary pressures”.