Monetary policy normalisation and receding fears of a trade war should help currencies recover, especially the Swedish krona, Norwegian krone and Mexican peso.
Barring a commodity price shock, significant wage pressure or faster monetary policy normalisation, currency volatility will remain low in coming months. However, undervalued currencies could still perform well, supported by the global economic recovery.
Nordic currencies to recover
These last few years have seen central banks introduce zero interest rate policies to fight deflation and prop up bank lending. However, now that inflation has turned up – slightly – major central banks including the ECB are looking towards the exit. This should help neighbouring economies normalise their own monetary policies, driving their currencies higher.
In early 2015, the Swedish Riksbank adopted negative interest rates to curb currency appreciation and defuse deflation risks. Now that inflation expectations are back around 2%, there is less of a need for such easy policy in a country where the currency remains sharply undervalued.
In Norway, the krone has been dragged down by recent oil price weakness, leaving it almost 20% undervalued. However, a lasting economic recovery and a pick-up in oil prices should lift the currency.
Mexican peso to benefit from fading trade war concerns
President Trump’s election raised concerns of broad-based trade friction. Mexico was most vulnerable given its strong integration with the US economy (offshoring of US businesses, huge remittances from Mexican workers employed in the US, widening trade surplus with the US since the implementation of NAFTA in 1994). Political uncertainty has weighed considerably on the Mexican peso and we think it is still undervalued despite an impressive rally since early 2017. Although NAFTA concerns won’t disappear, the strong economic readings in Q1 bode well for the currency, which should also benefit from modest rate hikes in the wake of the US Federal Reserve and the limited impact of targeted adjustments in the NAFTA.