LONDON (Reuters) - The euro could hit parity against the dollar next year, as Europe contends with political uncertainty and a weak economic recovery, but sterling looks oversold, according to Investec Asset Management.
Philip Saunders, Investec’s co-head of multi-asset growth, told the Reuters Global Investment Outlook Summit on Wednesday that divergence in U.S. and euro zone policies and prospects would push the euro lower. The United States is expected to embark on a fiscal splurge under its newly-elected president.
“We have seen the euro weaken and I can easily see parity in the euro against the dollar,” Saunders told the London summit.
“Although in aggregate the euro zone runs a current account surplus with the rest of the world, it’s going to be a funding currency like the yen, which means capital outflows are likely to persist.”
Funding currencies are typically those with low interest rates which are borrowed and used for buying higher-yielding assets elsewhere.
In contrast to Europe, the United States is expected to swing towards more budget spending, while tightening monetary policy. The U.S. Federal Reserve is seen raising interest rates in December and following up with gradual hikes in 2017.
Saunders said Europe remained challenged by the political establishment’s inability to come up with meaningful policies to foster sustainable economic recovery, while the European Central Bank remains wedded to quantitative easing.
Meanwhile, a packed election calendar next year will provide voters with plenty of opportunities to express their anger. Elections in Germany, France and The Netherlands are expected to see right-wing populist parties gain ground.
“Increasingly people are of the view that excessive reliance on monetary policy isn’t the answer, so what have you got? The answer is nothing,” Saunders said.
“And if nothing else is going to happen, then the currency takes the strain.” For the time being he is “pretty short” euros, he added.
In terms of political flashpoints, he said Italy was the weakest link and that its Dec. 4 referendum on constitutional reform could ultimately lead to Italy leaving the euro zone. June’s vote in Britain to quit the European Union was “the crack in the dam,” Saunders added.
The Brexit vote has hammered sterling, which hit a 31-year low in October.
But Saunders said he had been buying the British currency, taking the view that it was oversold.
“The final nail in sterling’s coffin was a policy error on the part of the Bank of England: they cut rates too precipitously and engaged in more QE,” Saunders said.
Although the British economy was fundamentally weak, with a big debt-to-GDP ratio and current account deficit, he said he was “quite comfortable” owning sterling at present.
“It’s a question of degree - it has held up pretty well against the strengthening dollar.”
Saunders said the dollar would enjoy another leg up, and at some point next year predicted 10-year U.S. Treasury bond yields would rise to around 2.75-3.0 percent as the Fed raises rates.
That may present significant headwinds for equities, particularly emerging markets, which have sold off heavily in the past week in line with a rise in U.S. yields.
While Saunders has trimmed exposure to emerging markets, he reckons the sector can still deliver positive returns next year as bargain hunters step in after a few months of weakness. But gains could be “back-end rather than front-end loaded”.
“Fears about raging protectionism are overdone,” he added, a reference to worries that Trump will tear up trade treaties and impose tariffs.
Investec Asset Management manages assets of $117 billion.
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Additional reporting by Helen Reid; Editing by Catherine Evans