For 2018, HXL expects the U.S. dollar to weaken against the Euro, remain unchanged against the Pound and strengthen against the Yen and commodity currencies. Despite small pockets of risk in Europe, North America and Asia, the outlook for global economic growth looks positive and we forecast global GDP of 3.8% in 2018 and 2019, up from 3.1% in 2016. The Chinese economy appears to be resilient and heading for a softer landing.

Interest rates will be a major driver for where investors will park their funds. Higher inflation leads to higher interest rates. Higher interest rates attracts more foreign capital inflows from investors drawn by the promise of higher interest returns.

U.S Dollar

As we have written previously, the USD will have its worst year in more than a decade despite the Federal Reserve continuing its current cycle of interest rate hikes into 2018. An increase in rates would normally benefit the dollar as investors purchase U.S. assets in anticipation of higher yields.

Hampering the USD is the lack of inflation, which will put-off the Federal Reserve from increasing interest rates to levels that are expected by the markets. If this fails to eventuate, recent increases will not be sustainable.

Overall the USD is expected to weaken against the EUR and patchy against other G10 currencies.

Euro

We expect the EUR to continue to stay above 1.20 in 2018 underpinned by improving economic growth and strong equity inflows into Eurozone as investors sell the USD and seek alternative investments.

The outcome of government coalition talks in Germany, Italy’s general election on March 4 and developments surrounding the European Central Bank (ECB) quantitative easing program (QE) will be key issues affecting the EUR.

We expect the EUR to rise throughout 2018 but remained capped until after the Italian election. Italy’s dysfunctional government, economic stagnation, a troubled banking system and high debt levels are worrying markets again as the prospect of a hung parliament may occur bringing further uncertainty. After this, investors will focus on the ECB and contemplate how quickly they will close the program and when to tighten monetary policy. We expect QE to be closed by Q3 2018 giving the ECB the ability to raise official interest rates.

QE keeps interest rates low with the aim of keeping borrowing costs low in the hope of stimulating investment and economic activity. However, this negatively impacts the value of the EUR.

Yen

HXL expects the Yen to underperform throughout 2018 as Prime Minister Shinzo Abe’s super-majority in parliament will continue to promote an expansive monetary policy and as the result, the Bank of Japan (BoJ) will continue to print money and keep interest rates at historic lows.

The BoJ has been fighting deflation for decades. So keen are the BoJ for people to go out and spend it actually costs money to deposit funds in a Japanese bank (negative interest rates). Global economic upturn is expected to bring inflation back to Japan which will lead to the BoJ to end its expansive monetary policies and give it the ability to raise rates in order to stop the outflow of money to higher yielding foreign investments and attract new foreign capital with the promise of higher returns. As inflation increases, the Yen will stabilise and will likely increase in the later-half of 2018.

Australian Dollar

Recent global and domestic events has seen the AUD fall below fair-value. We believe the AUD will increase slowly throughout 2018 supported by positive global growth, a resilient Chinese economy and positive risk sentiment for carry trades. However, macroeconomic conditions of low inflation, weak wage growth and a relatively high household debt appear to deter the Reserve Bank from raising interest rates anytime soon. The RBA has kept rates at 1.5% for the last fifteen meetings and a rate rise will not occur until the end of 2019.

One of the reasons why the AUD has underperformed over the recent months is the 25% fall in value of iron ore, Australia’s number one export earner, since August as China attempts to fight inflation and reduce dependence on iron ore to power its electricity plants in order to reduce pollution levels.

As we have mentioned previously in another research report, we expect the Chinese economy to grow steadily over the coming years which will mitigate the risks of Australia’s large exposure to China.

Economic growth, inflation and wage growth will likely remain subdued next year with the RBA keeping rates on-hold at 1.5% making interest rate returns higher compared to other developed nations. For example, investors may borrow in GBP at lower interest rates and invest in higher-yielding Australian assets thereby increasing the value of the AUD.

UK Pound

We forecast the GBP to make further gains against the USD in 2018 as U.S. inflation remains subdued despite a broad strengthening of the economy. Investors should be aware that despite recent progress between the European Union (EU) and the UK government, there is still some uncertainty regarding Brexit negotiations and the UK economy still faces some macroeconomic challenges ahead.

GBPEUR has traded within a 12 cent range during 2017 and ended the year with an overall loss of 4%. Continuing drama around the EU-UK divorce bill and the Bank of England (BoE) raising rates for the first time in a decade were key factors in why the currency traded very volatile.

For the next twelve months, the performance of the UK economy, Brexit and whether the BoE will raise rates again will influence the performance of the GBP. We expect GBP will fall against EUR and JPY in the year ahead. Even if the UK ends up with a favourable exit deal, it will not lead to a sustained GBP increase as there will be many more hurdles to overcome as it exits the European Union especially as we head closer to March 2019.

Canadian Dollar

In 2017, the combination of the Bank of Canada (BoC) raising rates from 0.5% to 1%, the recovery in the price of oil, Canada’s premier export, and the country’s stable political environment, fuelled strong rallies in the CAD. Higher interest rates are a major driver of currency appreciation as they attract currency inflows with the promise of higher returns.

Overall, the Canadian economy remains relatively robust and could be positively influenced by faster U.S economic growth on the back of recent tax-reform changes implemented by the Trump Administration. However, we expect the CAD to be weak against the USD in 2018 as Canadian inflation outlook remains soft and the BoC becoming more cautious again after the CAD appreciated heavily after two rate hikes and will initially follow the Federal Reserve rate hike speed to prevent the CAD appreciation against the USD.

Another major issue for the CAD in 2018 will be NAFTA (North Atlantic Free Trade Agreement) renegotiation with the US and Mexico. Like Brexit in the UK, this uncertainty is causing businesses to hold back investment until either further details are announced or a new deal is ratified.

New Zealand Dollar

The NZD had a tough 2017 going from one of the strongest currencies in the G10 to one of the weakest due to political uncertainty and falling dairy prices.
Since July 2017, the global dairy price has been on a downward trend which is having a negative impact on the NZD as the country’s largest export is whole dried milk from its important dairy sector. Falling dairy demand is reducing demand for the NZD from international buyers.

Political uncertainty following the formation of a new coalition government has also seen the NZD sold-off as the government takes a protectionist stance on foreign ownership of property which will limit incoming inflows of foreign investment, further lowering the demand for the NZD.

Despite the NZD being undervalued and historically outperforming in periods of global economic growth, for 2018 investors will be focused on two potential sources of risk. First, what policies will be introduced by the new government what will impact foreign investment. Secondly, changes to the Reserve Bank of New Zealand’s (RBNZ) dual mandate of full employment and price stability may affect the independence of the bank.

HXL Partners

CategoryForeign Exchange

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