FX Moment: Iran War and Assessing the Shifting Dollar Narrative

Welcome to FICFocus, where Bloomberg Intelligence fixed income credit currency and commodity strategists and analysts discuss their short and long-term views on debt markets and issuers. Now here's the Bloomberg Intelligence FIC research team. Welcome to FX Moment, which is part of our FICFocus podcast series. My name is Audrey Child Freeman. I am Chief FX Strategist at Bloomberg Intelligence. And today I am joined by my colleague Steven Chu, who is Chief Asia FX and Rite Strategists and who is based in Hong Kong. Hi Steven, thank you for joining us. Good afternoon Audrey, thanks for having me. The podcast is recorded on March 4th at 11 a.m. London time. Basically given the global geopolitical developments of the past few days and the war in Iran and given the market implication that we've seen over the past three trading sessions, I thought it would be very interesting today to first of all understand the shift in the dollar narrative and to present how we see it going from here, how we expect the dollar narrative to evolve from here and whether at the moment at this point there is a case for us to adjust a midterm outlook for the dollar. So first of all, I think it'd be quite interesting to understand how the dollar narrative has shifted since the start of the war in Iran. So there's two main channels that I had identified. The first channel is what I call the risk of channel. So basically we've seen quite a significant increase in risk aversion, the equity market that we take as a proxy here. It's down across the board. I think I looked at the Euro stocks 50 this morning that was down about 6.5% since the high of this year as we speak and clearly we are seeing a context and a narrative in which the heaven arguments for currencies is driving. And in this context the dollar is the ultimate outperformer and has been. I think people got confused a little bit earlier in the year when we were arguing in favor of diversification strategies, structural dollar downside as a way to address the evolving geopolitical context and the argument remains valid. But that's a different argument form. What do you do when you have a large scale global market risk of move across all asset classes? And in that context you look back risk of period after risk of period and the dollar always wins because of its liquidity virtues in particular. The dollar always stands to outperform during episodes like that. The last one we had was looked back in December 21, October 22, when the S&P actually was down around 25% over that period. And the dollar rallied about 14% on the Bloomberg dollar index basis. So this is something that we've seen happen time after time and it kind of feels like that's the direction we're going at the moment. And that's why right now I kind of feel that pushing against dollar the dollar bull view is pointless. The second channel through which the current environment is helping the dollar is when you start to think about the macro consequences of the war in Iran. Of course the macro consequences the way we think about it is that you have a substantial increase in all prices, I mean over 40% since it's generally low. We don't know where that will set or eventually we don't know whether we will be in the world with persistently higher oil prices or whether we will see a pull back down if and when the conflict ends. And that brings a lot of uncertainty as to where is your midterm inflation profile going to show for the US but also for the eurozone for the world economy. And as a result of that what are the implications for the monetary policy outlook? And as far as we are concerned what are the implications for what we had you know we had the year driven dollar negative view that we were expected to be validated by more rate cuts from the Fed. But this can be question now we are not sure as I said where oil prices will eventually be trading six months down the road or three months down the road and what will be the implication for the inflation profile for the Fed and hence for the Fed policy narrative. And as a result of that I think the path of this resistance is for the dollar to strengthen there was also a strong element related to positioning here where we were the market was under way dollar at the beginning of the year and there's a big rethinking as to the macro narrative in the second half of the year. And even if you don't go bullish at right bullish the dollar you probably want to actually think about adjusting your view to at least not being as negative as you were a few months ago. And I think that's what's happening. And of course there's the other side of the equation where you think about it in terms of higher oil prices who's an oil exporter who's a net oil importer and as a result of that who's better positioned to absorb a higher oil price in terms of real economic consequences. And here the answer is pretty straightforward again in the G10 space I'm thinking US net oil exporter, US economy resilience more likely to be more resilient that for instance than the Eurozone or the Japanese economy. And that's probably one of the reasons why the yen has been under performing despite this risk of context that we've seen over the past few days. So that probably now that I've spoken about the yen a little bit as well that is a good opening to talk about Asia and what's the perception of what's going on in the world, in the currency space right now Stephen. That's the recent headline of the change your views on the Yuan. And let's start with you know we can talk about the cycle but let's start with maybe the kind of heaven virtues of the Yuan. Do you think that the Yuan is getting a boost here in the current context? Thank you Audrey. Yes indeed. Yuan has been one of our favorite currency since the second half of last year. For domestic reason really I mean from a structural perspective it has very strong exports of huge trade surplus and a lot of dollars to be converted and then we saw FDI recovering as well. So basically the Yuan has been strengthening even before this event and also regardless of what happened to the dollar. And over the last few trading sessions it's pretty apparent of course the Yuan also dropped against the dollar but it's only like half the percentage point and versus the other Asian currencies it's one of the well in fact apart from the Hong Kong dollar which is packed to the US dollar the Yuan is the best performer. So it doesn't really change our view in fact you mentioned earlier that when we look at the winners and the losers out of this whole Iran war we have to pick the net oil exporters to be the winners and of course net oil imports us to be the loser. So for exporters we can easily look at Malaysia. So Malaysia has been one of the strongest currency earlier this year and it's the best performer over the last two years. So we like it still despite of this outbreak of the war it's still one of our favorite along with the Yuan and of course a regional safe haven is the Hong Kong dollar and the Singapore dollar has been our favorite as well because obviously we can't forecast or perceive a war happening but indeed we somehow we forecast there would be some uncertain events under the current US administration and hence we like safe haven currencies even before entering this war. So the Hong Kong dollar outperform and the same dollar also perform quite well. So these are the group of currencies that we like. On the contrary of course net oil importers are the underperformers. Namely we have the Indian rupee and then we have Japanese yen Audrey mentioned a little bit Philippine pay show and tie back. So these are all the ones that are prone to further downside if there's further spike in oil prices I think it's get worse. So in short the bottom line is interestingly even with or without this entire event and with or without an oil price spike our view remain unchanged because so happened. We were entering this year bearish those oil importer currencies because of different reasons because of local structural reasons because of fiscal uncertainties because of political uncertainty. So we would not change our view despite of the latest development and we're still like the UN and the net oil exporters the most within Asia. Okay, that's a very interesting summary. Can you tell us a little bit more? I mean in London here, we hear a lot of headlines about the Korean one over the past few days been quite hectic, I would say. Can you give us a little bit more insight maybe on that price action? Yeah, absolutely. Korea, it's one of we just mentioned about we want to underweight the net oil importers and South Korea is one of the big net oil importers here in Asia. So from that perspective, if market trade under Iran won narrative, then the one is one of the very obvious pick. But even beyond that, there are a lot of reasons for the one to drop. For example, it's a very high beta currency, very sensitive to risk sentiment. So given this event is clearly a risk of events, so that hurts the one as well. And hence, we are also seeing equity sell off in Korea, which hurts the currencies. And more interestingly, even without this event, we were somewhat bearish on the currency because of the US trade deal commitment. So Korea has committed $350 billion of investment into the US. Of course, they will cap that amount to $20 billion a year, but that's still quite a large amount. So as long as Korea continue to honor that deal, there's this natural outflow pressure that hurts the currency. And there's also the continued outflow of equity investment by the Korean residents into overseas equities in particular, the US stocks. So these are all the factors that are underweighting the one even before the Iran war. So the war just makes things even worse for the one. And hence, you saw headlines about the one dropping beyond $1,500 per dollar. And that's the weakest since 2009. Yeah, so I've seen that on the chart. We've seen quite significant moves in the market. As supposedly, liquidity can be an issue as well for those currency pairs at times when you see quite significant and deep price action like we have in the past few days. Sivan, there's another, I mean, it's always on the border line of our space and what I'm thinking about is gold. I know you've written a lot of very good research on the terminal on gold or where we covered gold. For me, the whole situation, I know the price action on gold has been, we've seen a pull back in gold prices. But for me, the current situation doesn't really alter my view on gold. I still feel that there's a very strong merit in case for being bullish gold in terms of allocation strategies. Positioning is something that we always bear in mind. And just like for the dollar underweight at the beginning of the year, this probably the gold overweight. And when you see equity down so much, perhaps there's a positioning effect here that comes into play. But just tell me, what's your thinking on gold here? I mean, gold is super interesting, especially for this event. Because usually if you have such a backscal geopolitical event, you can imagine gold would be rallying through the roof. But in fact, this time you can see that the rally was pretty modest and it even pulled back, as you said, even dropped back a little bit over the last one to two trading days. So that tells us that very clearly all the price action over the last few days to some extent is position adjustment. So of course, the dollar rally a lot. But instead of saying, oh, so now markets are back to like full blown believing in the dollar to be the best choice, believing the dollar to be the best safe haven reserve currency, it's probably more liquidity search and an adjustment in position. Just because we enter this year's shorting the dollar, expecting more downside, it's very natural for the dollar to rally on the back of any risk of event. So gold this time tells us a very interesting story. But going forward, if we still talk about the structural dollar debatement or the theorization, however you call it, a weaker US dollar, then gold would still be the go to currency, coin, quote, and still be most optimal option in terms of reserve assets. Of course, the upside from here from $5,000 per ounce, it's going to be a lot less compared to last year. Last year, we were talking about 66% annual growth in the price. So this year, even if the gold still managed to rally a little bit and end a year higher, the extent of headroom will be a lot less compared to last year. And I think that's a very fair judgment for the gold trend. Yeah, I think there's another point. I think the correlations, the whole intra asset class correlation have been questioned all year. They kind of come back into play at the moment because we've seen this big risk of move. But I kind of feel that this is like you do. I kind of feel this is a lot of this is position driven. And you know, it's very difficult to prove it and to quantify how much of that is position driven. But you know, this is how it feels. And for me, the outlook for the dollar now is on the G10 space anyway. I think it is still a lot more difficult to be dollar negative now than it was three months ago, just because the macro case, even before the Iran situation, for me, I was already kind of flagging the fact that the US economy was showing quite a lot of resilience and that the yield driven case, weaker dollar case was a little bit lacked kind of needed anyway. What I was talking about in my notes was we needed data validation. I still think that's true. And on top of that now, I have to kind of try and understand to what extent the inflation profile for the US is going to be impacted by the current surge in all prices. And it will be we know the direction, but we don't know how long. And we still don't it's very difficult right now to have a strong view as to what extent this affects the fed policy expectations. And that could be I think the game changer for the dollar. If we were to see a U-turn on fed policy expectations for the second half of the year, we are not so long ago. Remember, we were pricing two or three rate cuts from the fed. And now we kind of rethinking. Will that really happen? So for me, this is what's going to be very important to monitor beyond the how long is the risk of context going to last for once you see a stabilization in the risk environment. You probably see the dollar weakened again. But then the next leg from there, I think will be macro driven again. And inflation is we spent so much time looking at growth and thinking about the US economy and the labor market. I think the second half of the year, we're probably going to spend a lot of time thinking about where is inflation heading from here. And as a result of that, how do we shape our dollar view? But anyway, we covered quite a lot here. I think it was very timely, very interesting to kind of share how the situation in the Middle East is shaping our view on the dollar going forward. Steven, it was great to have you back on the podcast today. And thank you for sharing your views on HIFX. All of your work is greatly appreciated on the on the terminal. If there is anything that Steven or myself discussed today that you want to talk about, please reach out. I'm reach out on the terminal to Steven or to myself. And I'll leave it here. Steven, thank you so much for joining. Thank you. It's a pleasure. And until next time, goodbye. Thank you. Thank you.