Biden’s confirmation as the 46th POTUS means a nearly 10-year period of USD outperformance has come to an end, driven by a renewed period of Emerging Market (EM) asset outperformance. The USD, in our view, will enter a period of depreciation. As risk sentiment improves amidst historically low Developed Market bond yields, it is likely that there will be re-allocation of capital from cash and risk-free securities to higher-yielding assets, especially in EM.
The global economic recovery is uneven, in large part stimulus-fuelled, which should support the emerging recovery in commodity markets and drive the broader re-allocation towards EM.
The CNY was one of the best-performing EM currencies in 2020. Its recovery has been led by strong currency fundamentals in spite of heightened US-China tensions. These fundamentals include wide growth and interest rate differentials in the CNY’s favour, as well as China’s stable current account surplus. We believe these supportive fundamentals will remain in place and expect the CNY to appreciate in H1 2021. Over the course of 2020, we have seen record inflows to China’s bond market from foreign investors. YTD inflows have reached CNY771bn, up 86 per cent year-on-year, supporting the CNY.
Asia continues to lead the recovery in EM LCY returns. Asia ex-Japan (AXJ) currencies are expected to recover from their underperformance in 2020, which was caused more by external factors than domestic fundamentals. Key amongst these was the uncertainty surrounding the US election outcome, which could have prompted a surge in UST yields and US rates volatility if there had been a Democratic clean sweep leading to a fiscal spending programme of as much as USD3.9tn. Now that these fears have been put to rest, with the Biden administration facing a divided Congress, we expect a more synchronised recovery in AXJ FX.
The high-yielding currencies in the region – the INR and IDR – stand to benefit from stable nominal UST yields, accommodative global monetary policy, and rising outstanding negative-yielding debt. Meanwhile, trade-dependent currencies – the SGD, MYR and THB – are likely to gain from Biden’s expected multilateral approach to global trade.
Europe is suffering from a resurgence of COVID cases, raising questions about the region’s economic recovery, as well as prospects for the EUR. While we acknowledge the short-term economic risks faced by the region, we still believe that the euro area will outperform the US recovery in 2021. Further, while the ECB’s balance-sheet expansion has outpaced the US recently, with its balance sheet now at 65 per cent of GDP, we expect the Fed to have to increase the pace of asset purchases in the absence of fiscal stimulus. Overall, we remain constructive on EUR-USD.
EM currencies, especially in Asia ex-Japan, can pick up the slack from any potential EUR underperformance. The strength and stability of the CNY, combined with improving momentum in EM trade, should offer further support for AXJ FX. Asia has led the recent recovery in EM LCY debt markets, and we anticipate that AXJ FX will perform in a similar fashion in 2021.
Outside of Asia, we remain positive on the MXN and the ZAR. Both currencies are likely to benefit from the search for yield and improved prospects for global trade. A robust global industrial recovery favouring manufacturers and commodity exporters, and declining political risk post-US election, allow investors to put more capital to work across emerging markets.