The 'debasement trade' gains traction

The macro point

Are we on the brink of major changes in the international monetary system? Probably. Long-term trends - like the dedollarization begun by emerging countries after the 2007-08 financial crisis - are amplified by short-term decisions made by financial markets. Should we expect the "debasement trade" to continue? We think so. Financial markets are increasingly doubtful about the Americans' ability to reduce the deficit, and their willingness to do so. Furthermore, the next chair of the Federal Reserve (Fed), regardless of their name, will be under pressure from the White House to drastically lower interest rates. This should not, in our view, call into question the independence of American monetary policy. However, it could exacerbate concerns about the balance of power across the Atlantic.

It is likely that the "debasement trade" and the resulting flows (exit from American financial markets and shift towards Europe and emerging countries) will be the main marker of the foreign exchange market this year – with direct effects on currencies far more significant than geopolitics or central bank decisions. Under these conditions, we expect the Dollar Index (which measures the dollar's performance against the currencies of the United States' main trading partners) to continue to fall this year, probably by about -4/-5%. For now, it remains in a wide range between 97 and 100. But everything indicates that a further decline is only a matter of time.

Contrary to what is sometimes mentioned, we doubt that the Chinese yuan can benefit from the "debasement trade." When we observe capital flows in China, they are mainly related to domestic investors (particularly households who rely heavily on this market). Foreign institutional investors are not returning. China is, probably rightly, still perceived as high risk. The latest Chinese statistics are poor. They show that demand for credit – a good proxy for estimating domestic demand – is close to zero. Moreover, the recent purge within the army does not inspire confidence. It sends the message of a contested central power trying to regain control.

Our opinion: current concerns about the dollar will short-term favor the emergence of a fragmented international monetary system which should particularly allow the euro and currencies of major emerging countries to stand out. The Swiss franc, which played its traditional role as a safe haven in January, should also fare well, especially if geopolitics continues to be disruptive. This is likely. The drama linked to Greenland is not over.

Technical point

Unsurprisingly, a direct consequence of the ‘debasement trade’, EUR/USD hit a new peak last week at 1.20 before profit-taking occurred. The market consensus now anticipates that EUR/USD will reach 1.2250 or even a peak at 1.25 before retreating. If so, the fluctuations of the pair would be quite similar to those of Trump's first term. It’s a coincidence. But it’s rare enough to note. Another important fact, the authorities in Washington rather welcome the fall of the dollar, which remains overvalued against the euro. Several Fed studies have highlighted that the strength of the greenback has systematically resulted in a decline in exports. One doesn’t need to be a great cleric to know that the dollar’s depreciation is just beginning.

Announcements to follow

It should be expected that the Fed will be under pressure from the White House this week after keeping its benchmark rate unchanged as expected. U.S. employment figures for January will be crucial to determining whether a rate cut is possible in March. That is our opinion.

Finally, no change in monetary policy is expected from the European Central Bank (ECB). The terminal rate is at 2%, according to us. The same goes for the Bank of England (BoE), which should opt for keeping rates unchanged at 3.75% this week. This has already been factored in by the market and the British pound.

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