Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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High yielding currencies will start to lose their appeal
Charu Chanana
Chief Investment Strategist
Summary: As we step into 2024, focus turns from bond yields and inflation stories to growth resilience and relativity. The USD decline may take some time to get entrenched, until the higher-for-longer narratives for other global central banks are tested. JPY and Asian currencies have significant room to rebound in a yield-driven, bearish dollar environment, but geopolitics and elections remain a key risk.
USD downtrend will be bumpy
December marked a shift in central bank policy expectations, with the Fed taking a more dovish stance and signalling rate cuts. This has reversed the dollar's recent strength and could lead to further depreciation in 2024. However, sustained dollar weakness will require the Fed to implement easy monetary policy, as well as economic growth outside the US to outperform.
While the Fed's dovish turn could support a dollar decline, US macro exceptionalism is likely to maintain some upward pressure. Economic data in the Eurozone and UK may deteriorate faster, providing temporary dollar support in Q1. A sustained dollar decline will have to wait for a more pronounced deterioration of the US labour data.
The hawkish stances of some major central banks, such as the ECB and BOE, could be challenged by weakening economic data in Q1. This could pressure the EUR and GBP, particularly if markets push forward the rate cut expectations for these central banks.
The big BOJ pivot may never arrive
The big market bet for Q1 is likely to be whether the Bank of Japan (BOJ) removes negative interest rate policy (NIRP) and yield curve control (YCC). There is a sense of urgency as the BOJ is losing the window of opportunity to pivot. Global central banks are likely to shift to neutral-to-dovish stances during 2024. However, we think that the BOJ’s exit policy will be gradual and modest, and markets are likely to be disappointed if expecting a complete removal of YCC. Both liquidity and political risks remain too high for the BOJ to consider a full exit from the YCC, and moving before the results of wage negotiations are out could hamper credibility.
Having said that, the Japanese yen is a BOJ problem with a Fed solution, and it has the most potential to rebound in 2024. Some help could continue to come from expectations of a BOJ pivot before a likely disappointment later in 2024. The start of the global easing cycle could also serve as a warning sign for FX carry strategies as policy divergences narrow.
Room for recovery in Asian FX marred by geopolitical risks
The Bloomberg Asian dollar index slumped 5% until October, before a dollar slide brought some respite in the last two months of the year. As the dollar remains depressed in 2024, there’ll probably be more scope for Asian currencies to appreciate from a valuation lens. Any signs of an economic recovery in China, or measures to continue to prop up the yuan, would bring added benefit to Asian FX.
North Asian currencies, particularly KRW and TWD, could benefit if the upturn in the semiconductor cycle extended further. However, concerns about a global recession could come back to haunt the exporters such as KRW, TWD or SGD, while domestic-demand driven FX such as INR and IDR could outperform.
Geopolitical developments, particularly the state of current Russia-Ukraine or the Middle east wars, as well as the Taiwan elections, could hinder the recovery path for Asian currencies.
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