2017 Review: USD Doldrums
In many respects 2017 was a good year with the global economy growing well and with the US Federal Reserve able to gradually normalise its ultra-lose monetary policy and slowly raise interest rates. It is now looking at reversing its quantitative easing programme and is way ahead of the other major central banks in terms of normalising monetary policy.
However, this didn’t translate into a USD rally - indeed, this outcome had been priced in several years before so what has transpired despite the good progress of the US economy was steady USD weakness, which was played out on the currency crosses.
Also, despite the fanfare created by US Donald Trump and his promises to disrupt the establishment and fire up the economy to produce octane fuelled growth with tax cuts and infrastructure spending, what actually transpired was something a lot more mundane.
Instead the markets were greeted by lots of political drama and tantrums but not much on the legislative front until recently, while the economy continued to chug along nicely and the Fed carried on normalising its monetary policy.
Overall USD bulls were left disappointed.
The real star among the majors in 2017 was the single currency, which triumphed despite its well flagged economic contradictions, growing populist disillusion with the EU project and the fact that the Union is losing one of its key members - the UK.
Indeed, 2017 can be described as a triumph for the European Central Bank (ECB) and its quantitative easing programme, which finally seems to be reaching parts of the Eurozone economy, its previous efforts weren’t getting to.
Also, the various elections across the EU didn’t produce a national leader committed to taking their country out of the EU. France, for instance, got President Emmanuel Macron, who on the contrary is fully committed to ever closer union. Although Austria did vote for a far-right party - it has dialled down on its hard-line rhetoric and remains committed to the EU, albeit with more powers for the nation states. But overall it does not appear to be a threat to the integrity of the Eurozone and the EUR.
If Merkel’s Christian Democrats end up in coalition with the Social Democrats, what could transpire given Macron’s aims, is much faster and deeper EU integration with the UK no longer in the way to block it.
On the surface this will be good for the EUR - however, it should be noted that in all of the recent national elections, anti-EU parties all gained voter share. If the sentiments that underpin that trend are not addressed, the next election cycle could sweep one of them into power unleashing chaos in the Eurozone.
Meanwhile, the EUR held ground despite an unsuccessful bid by independence politicians to break Catalonia away from Spain. It looks like Spain has regained the initiative for the time being, but its an issue, which could once again flare-up in the future.
GBP hanging in there
Despite the Brexit dramas and the constant din of predictions of the demise of the UK, which didn’t happen, GBP actually gained against USD during the year and even against some other currencies such as JPY (well only just), but retreated against the rampant EUR.
However, the UK managed to strike numerous own goals, which somehow didn’t derail GBP that much. Those largely reflect the fact that the UK’s ruling establishment still has not come to terms with Brexit and remains intensely divided over it.
It’s a situation, which the EU is managing to exploit incredibly effectively to the UK’s long-term detriment.
Possibly the most spectacular blunder was Prime Minister Theresa May holding an election in June managing to translate a massive initial lead in the polls into losing MPs forcing her into an alliance with a small political party in Northern Ireland.
Meanwhile, her fragile government has attempted to negotiate the UK’s exit out of the EU, and due to its weakness and strong political opposition at home, has steadily conceded a whole host important points, which could create real trouble for the EU-UK relationship later on and tie the UK to EU’s regulatory structures, which it needs to untangle itself from if it is to succeed in the long run as an independent country.
However, GBP bulls were relieved that phase one of the negotiations has passed with the UK having made some potentially monumental concessions, which if an eventual European trade deal is agreed, will be implemented. This will severely hinder the UK’s ability to negotiate trade deals with the rest of the world, for instance. The next phase will no doubt see the UK continuing to make large financial contributions to the EU’s budget in perpetuity, possibly ended up with some sort of EU-lite membership where it is essentially a rule-taker.
JPY started Q1 2017 in full retreat and later stabilised while the Bank of Japan carried on bravely trying to reignite inflation and keep the Japanese economy growing.
This of course involved continued monetary stimulus and so far among the major central banks looks the furthest behind in exiting its ultra-stimulative monetary policy — behind the UK and Eurozone even.
Nonetheless there were some improvements in the Japanese economy, which remains severely constrained by its rapidly ageing population.
Japan has nonetheless rode on the coat tales of a relatively strong global economy helping its exports and returns on overseas investments. If this continues throughout 2018 pressure could surface to start reining in the BoJ’s stimulus.
But regardless of Japan’s economic and political challenges, political instability and uncertainty don’t appear to be among its problems with Prime Minister Shinzo Abe comfortably winning the election October. This should enable him to keep pump-priming the economy well into 2018 and maybe even beyond.