2018 Forex Outlook
As it turned out, 2017 wasn’t such a bad year. Unfortunately, 2018 may turn out to be more challenging. The global economy could well be in its final phases of economic growth before a slowdown takes place. Admittedly, that could happen in 1019 or 2020. Indeed, European economies tend to do well towards the end of those phases as is currently happening now.
Meanwhile, polls across many major economies continue to show that voters think their leaders are taking their countries in the wrong direction. This dissatisfaction echoes a range of concerns from stagnant wages, cost of living issues through to unhappiness about mass immigration, terrorism and multiculturalism.
Unaddressed and for sure these are very difficult issues to fix - that spells social problems and political upsets and that generally translates into currency volatility. In France, President Emmanuel Macron is pursuing labour reforms and greater Eurozone integration - neither of which is popular with the populace as France is a left wing at heart and many French people are uncomfortable with Germany’s growing dominance over Europe.
Macron won the election largely because most voters didn’t want the alternative, namely Marine Le Pen’s National Front.
Meanwhile, Germany could also veer towards a government that wants to pursue greater Eurozone integration (depending on the outcome of the coalition talks) - an increasingly unpopular notion among many Germans who feel they already pay far too much in the name of European solidarity. Ignoring the will of the people could turn out to be disastrous in four to five years time with a fully fledged rebellion against EU and Eurozone membership across some member states.
In truth the EU is deeply divided with the West pitched against the East over immigration and North against the South over austerity while one of its key members, the UK, voted to pull out.
Meanwhile, Italy is due to hold an election before May and currently Eurosceptic parties are in the ascendance. This reflects years of economic stagnation in Italy and naturally voters want a change of regime.
The result of the Italian election could prove troublesome for the Eurozone and could knock the EUR’s strong rally so far. However, like in Austria, where the far right won, some of Italy’s eurosceptic politicians have toned down their anti-EU language reflecting the fact that most Italians prefer the single currency to a return of the Lira. However, the election remains a dangerous wildcard for the Eurozone.
Also, the Eurozone’s growth spurt may start to falter at some point in 2018 unless it really has managed to grow independently of monetary stimulus. Another factor is that the global economy may not perform so well and oil prices started recovering as of July 2017 and this could be another drag on growth should 2018 see them move higher still.
Indeed, with all its tensions - the Eurozone still looks just one major election, referendum or political / financial crisis away from breaking up.
This year could see those ugly themes becoming dominant again.
But much will also depend on what happens in the world’s two largest economies. If the Eurozone can keep its act together, then there is a chance that the European Central Bank will begin to slow its monetary stimulus, in large part due to German political pressure to do so. As such this column isn’t optimistic that the EUR’s ‘lucky’ run can last much longer.
Watch out for G-2
And there are some concerns over the world’s two largest economies the US and China, which are so fundamental to global growth prospects.
Premier Xi Jinping has proved himself to be a formidable political operator and has massively consolidated his power over the last few years. For political reasons, the Chinese leadership wanted a strong economy in 2017 and duly delivered.
But now that Xi Jinping has completed his power grab, there may be less reason to keep the economy growing so quickly. The Asian Development Bank reckons it grew 6.8% in 2017 and that it could fall to 6.4% in 2018. Others think it could be lower still.
This is because China’s policy makers want to take the foot off the accelerator to sort out some of the country’s troubling structural problems.
They intend to implement a “controlled moderation” another way of saying they want the economy to grow in a more balanced and sustainable fashion as much of the current growth is of poor quality and too reliant on cheap and easy money, bubbles and speculation.
This could be the year that Xi Jinping really does quash the country’s credit-fuelled asset bubbles. But this could be risky given that Chinese non-financial corporations have racked up nearly $18tn in debt - far higher than their Eurozone and US peers — and many could go bust if the economy slows too much with asset bubbles also popping left, right and centre with damaging consequences for the real economy.
Two US risks
With the US there are two obvious risks. The first is political. US President Donald Trump remains subject to a creeping FBI investigation into his pre-election relationship with Russia. Should very damaging revelations emerge it could paralyse his administration.
In November 2018, the US holds its mid-term elections. Should they go badly for Trump, they could result in a lame duck presidency, meaning that he will not be able to carry out his promised economic reforms, even though he now seems to be getting the hang of working with the Democrats, particularly with the tax reforms. That would be a drag on USD.
The other risk comes from the US Federal Reserve. Firstly there’s the change of the Fed chair from Janet Yellen to Jerome Powell in February. That’s not expected to result in much change in policy, but could cause some short-term wobbles in USD as the markets get used to him.
Secondly and more importantly, the Fed is forecast to raise rates three times over 2018 while working on reversing its previous quantitative easing programmes thanks to strong economic growth and low unemployment.
But for an economy that has got so used to cheap debt, this could derail it forcing the Fed to reconsider its position. This would certainly be a USD negative and is a key risk for 2018. Central banks often go too far with tightening monetary policy and cause recessions as a result.
However, should the US economy prove resilient and Trump manages to remain in control, markets could start looking favourably on USD’s yield advantage over the EUR and JPY and could become subject to carry trades that would drive it higher. But somehow that scenario looks a tad too optimistic.
Likely EUR/USD range: 1.0500-1.2000
GBP could be a star performer
The UK meanwhile suffers from weak political leadership and one, which if current form is anything to go by, will steadily cave into one EU demand after another as it negotiates its exit from the Union. This will be very expensive for the UK in the long-run, but currency markets tend not to look that far ahead.
And ironically, this could be very good news for GBP over 2018 as the markets will interpret this as positive in terms of negotiating a two-year transition deal with possibly something resembling a free trade deal mainly for physical goods at the end of it, where the EU undoubtedly has a strong competitive advantage whilst for the UK it is in services.
Under those circumstances the economy may plod along at a moderate pace with the Bank of England raising interest rates once or even twice over the course of the year to quash inflation. The best way to do that would be to have a stronger GBP.
The sound of the negotiations going well and being dressed up as a triumph for the UK government could restore a lot of confidence in GBP.
However, there remains the problem of the UK’s large current account deficit that is clearly structural, which the markets have overlooked so far, and the fact that the short-term ability of the economy to grow appears constrained by a lack of productivity growth and with the consumer probably running out of capacity to keep borrowing to spend.
But the EU-UK negotiations will still produce plenty of drama (as the UK will want to show voters it worked hard to get a deal), which will see GBP volatility. It will at times appear as if the negotiations are at an impasse or close to collapse as has happened a couple of times already. But it’s all part of the political choreography and will provide some nice trends for currency traders.
Indeed, this column is increasingly optimistic that a EU-UK two year exit transition period and free trade deal for physical goods will be struck simply because it will be on the EU’s terms agreed to by a UK government desperate to make Brexit look like a success in the short-term so it has a chance of winning the next election.
The UK joined the EU in 1973 on very poor terms, partially redressed in 1984 (with the EU contribution rebate from 1985), and it looks set to repeat history on its exit. Once the UK establishment finds its feet, it will likely strongly contest the very unequal treaty its predecessors willingly agreed to for short-term political expedience. This will likely become a source of friction between the two for many years to come.
Likely GBP/USD range: 1.3000-1.4000
JPY could also do rather well
Japan has a stable government and its economy is growing modestly with the Bank of Japan likely to maintain its aggressive stimulus policies for quite some time.
On the face of it this is a negative for JPY (and will be if the global economy does well over 2018), especially as the other major central banks are moving on with varying degrees towards normalising monetary policy.
But this column is not hugely optimistic over the political and economic outlook for 2018 and that implies some risk-off phases and that means safe-havens such as JPY could do rather well - particularly if China’s economy does slow a bit too rapidly and the Fed goes too far in the US and / or some serious problems resurface in the Eurozone.
At least one of those scenarios is quite likely to come true over 2018, which could see JPY in a nice uptrend, even if it’s just for a while.
Likely USD/JPY range: 115.00-100.00