Market View for 2014
USD should be a 2014 winner
Conditions look set for USD to rally next year with the US economy showing some real vigour and the US Federal Reserve starting the process of tapering its quantitative easing programme from January. It should also be a good year for the global economy.
The markets will be looking towards economic growth gradually replacing quantitative easing and diverging real interest rate levels as the key drivers of forex markets next year. Though this looks like a return to more normal conditions there are a number of troubling issues to consider, which will be looked at later in this note.
After a few hiccups the Fed masterfully communicated its taper so as to be viewed as good news by the markets rather than a dreaded withdrawal of liquidity. It can happen because the news from the US economy has been so good recently. Shifting from QE to forward guidance on interest rates as a key monetary tool cheered the stock market, but has the potential to limit USD's gains in the short-term.
But if the US recovery does prove sustainable then there is good reason to expect that the Fed could even start tightening monetary policy in late 2014 early 2015 – putting it way ahead of the Eurozone and Japan in terms of the interest rate cycle. That should be bullish for USD.
EUR looks set for stability
The EUR defied expectations in 2013 by being one of the best performing major currencies. The toning down of the Eurozone crisis and increasing economic confidence all played a supportive role. Even the peripheral Eurozone countries are showing signs of improvement, which is crucial to the long-term survival of the EUR.
However, the Eurozone is still a laggard in terms of generating an economic recovery. So while the Fed is reversing its easy money policies, the European Central Bank will still be in aggressive monetary stimulus mode. But a strong US economy will be like manna from heaven for the Eurozone, which should start noticeably recovering by H2.
A strong US recovery does therefore limit downside risks for EUR/USD. But the upside is also potentially limited given 2013's strong gains and the fact it lags in the economic and interest rate cycle. EURUSD will probably trade in a range of around 1.3200-1.4000 next year.
JPY likely to run up more losses
Of all the major central banks the Japanese one looks set to be the most aggressive in 2014 in terms of easy money policies. On the face of it Abenomics seems to be working. Inflation appears to be replacing deflation, business confidence is up and the economy has shown some growth.
However, credit growth, which usually happens in tandem with a steadily expanding economy is not really happening and due to its rapidly ageing population, Japan's labour force is shrinking. If a US recovery proves sustained and lifts other economies Japan could benefit from export-driven growth.
A prevailing risk friendly environment will see Japanese investors pursuing growth and yield opportunities abroad. Forex traders meanwhile will be inclined to make more use of JPY for carry trades. USD/JPY is likely to be in a range of 103.00-110.00 next year.
UK tracking US closely
The long awaited recovery in the UK economy appears to be broadening as does the rise in real estate prices. Like in the US, the unemployment rate is steadily falling. The combination of a well supported GBP easing inflationary pressures and rising wages could see people's net earnings turn positive in 2014 for the first time in five years. Such an outcome will make the economic recovery more sustainable.
A more risk friendly environment will also be supportive of GBP and help attract capital to the UK, which will come in handy to fund the country's large current account deficit. And if the Eurozone recovers the UK may even be able to make some small progress in reducing its current account deficit.
However, the recovery is creating some debate that parts of the economy could start running into capacity bottlenecks next year, which would be potentially inflationary. Combined with rising real estate prices that could prompt the Bank of England to start rising interest rates late this year or in early 2015. Given the UK seems to be following a very similar economic and interest cycle to the US, it is difficult to see cable making very significant gains versus USD. The range on GBP/USD is likely to be around 1.6000-1.6700.
Gold should bottom out and recover
2013 was undoubtedly a bad year for gold. The Fed is to start winding down its QE programme, inflation has been benign, equities have soared, ETF liquidations have been big and the global economy appears to be on the mend.
But on the plus side for the bulls a lot of the hot money has exited gold leaving it in stronger hands. Asian investor demand has remained robust, particularly so in China. Eventually, Asian investors and possibly some central banks should gain the upper hand. But for now gold is still very much locked in a down trend and looks very likely to test lows of $1,000/troy OZ before recovering.
But given Asian investor appetite gold could well recover next year with the Summer period proving to be a turning point as it often is for the yellow metal. If Asian investors turn the market around it won't be long before the hot money returns to ride the wave up. Gold is likely to trade in a range of $950-1,200/Troy OZ over 2014.
As mentioned at the beginning of this note there are some worrying issues. From a demographics point of view the developed world and many emerging market countries, such as China, are turning Japanese. The growing composition of older people in the population is likely to lead to lower consumption in the long run and that in turn is a deflationary force.
However, demographic trends evolve slowly. It's possible that with banks in better shape and probably some limited pent-up demand the economy might be able to buck the demographic trend for a while, maybe even for all of next year.
Possibly related to ageing populations is the low labour participation rate in the US. If it isn't reversed via more jobs and more older people working then it will limit the growth potential of the US economy. To an extent some of the demographic tax can be counter acted by productivity improvements, which are relatively difficult to achieve, and immigration.
By Justin Pugsley, Markets Analyst MahiFX Follow MahiFX on twitter at: https://twitter.com/MahiFX