Global Currencies – Q1 2017 Wrap-Up

Political Risk Underscores Global FX Volatility

Kabir V writes on the FX Markets

North America

Political risk will have substantial implications for global markets throughout 2017. We have already seen the impact of Brexit and the Trump election in the past year, and as populism gains momentum, particularly in Western Europe, economic cohesion – and by extension the global foreign exchange market – will be further tested. The U.S. Dollar however, remains in a league of its own, having outperformed a basket of global currencies over recent months under robust domestic growth and reformed trade policies from the new administration. The U.S. recovery has outpaced its global competitors’, with full employment edging closer. Retail sales have risen on the year after a strong January, and consumer prices posted their largest gain in four years.[1] Wage data is also positive, with private payrolls at their highest level since April 2014.[2] The U.S. Federal Reserve is expected to raise interest rates three times in 2017 to keep inflation under control, following an initial hike in December 2016.[3] Contractive monetary policy should extend the Greenback’s surge, as higher interest rates draw in foreign investors in search of yield. Global investment has also poured into the US stock market; equity returns have seen an uptick since Trump’s election win, reflecting bullish sentiment surrounding prospective earnings-friendly tax policies and deregulation.[4] As investment shifts to USD-denominated assets, the Greenback appreciates in value, while capital outflows from rival economies depresses those currencies. Protectionist trade policies from the Trump administration should further drive up the USD; the new administration has threatened to effectively tax U.S. companies on goods and inputs imported.[5]

How long will the Post Trump bull run continue?

Despite the Greenback’s surge, the Canadian Dollar (CAD) held steady in Q4 2016 and is expected to keep pace with G-10 peers over the next few months. However, the Loonie will likely struggle to track the USD moving forward. Despite oil’s rebound driving commodity exports, the Canadian economy is still held back by insufficient business investment and weak non-commodity sectors. Given the low-growth environment, the Bank of Canada will continue with easy monetary policy to provide stimulus.[6]

Meanwhile, the Mexican Peso (MPX) seems to have emerged from a post-U.S. election slump, which stemmed from uncertainty regarding U.S. policy on trade and investment, in particular NAFTA. Now, the MPX is trading at 4-month highs following the softened stance from the U.S. administration, and the announcement from Banxico of a currency hedging programme that will auction off $20bn in USD hedge instruments.[7] The hedge programme is designed to steady MPX fluctuations without depleting FX reserves.

Europe

No other region has experienced the politicization of currency valuation like the Eurozone. The British Pound (GBP) is still recovering from last June’s Brexit decision. But the full effects are yet to be fully realized; the formal exit is pending Article 50 of the Treaty of Lisbon which will likely be invoked by the end of March.[8] With poor growth already forecasted for the UK, the added uncertainty surrounding these exit proceedings will apply further pressure to the GBP.[9]

Since Brexit, anti-establishment sentiment has spread to Western Europe, with three looming elections – the Dutch election mid-March, the French presidential election in late April and the German general election in September – that could usher in far-right, populist parties to power.[10] The economic platform for these parties is markedly anti-Euro and isolationist. As such, Euro (EUR) volatility has spiked in recent months, and the timing of these elections suggests the currency may not have a chance to stabilize for a prolonged stretch in 2017. Macro fundamentals suggest the Eurozone is actually faring well, with strong data emerging from manufacturing and service-oriented sectors, particularly in Germany, to temporarily boost inflation.[11]

However, loose monetary policy will apply further pressure as the ECB focusses on export growth. Ultimately, EUR stability will be challenged more by internal political dynamics than U.S. macroeconomic fundamentals, as Eurozone markets are more dependent on internal trade than open trade with the U.S.

Asia and Emerging Markets

The Japanese Yen (JPY) was the weakest G-10 currency in Q4 2016, largely due to diverging interest rate differentials with the United States.[12] The Japanese Central Bank seems unlikely to eschew “Abenomics” – fiscal stimulus, expansive monetary policy, and negative (or near-negative) rates. The JPY remains inversely correlated to U.S. interest rates and continues to trade almost exclusively as the low-yield side of carry-trades (with the USD, AUD, and NZD), an investing pattern that reaffirms its status as a “haven” or risk-off currency.[13] With periodic rate hikes expected from a bullish Fed, the investment outlook for JPY continues to be bearish for 2017.

Whether the JPY is excessively weak or low enough just to sustain export growth and drive consumer spending has been intensely debated of late. Japanese policymakers insist that JPY levels are stable and aligned with economic targets. The Chinese Yuan (CNY) has also softened on the back of decelerating growth, substantial debt overhang, and rising Sino-American tensions in the Western Pacific (link to previous article).[14] The forecasts for the CNY highlight significant capital outflows in 2016 – towards USD-denominated assets as alluded to above – which may grow in 2017.[15] However, it is expected that the Chinese Central Bank will intervene by adjusting exchange reserves to keep its currency within a specified band. A significant CNY depreciation is thus unlikely.

For the remaining Emerging Markets, an array of factors need to be weighed. Commodity-intensive emerging markets are expected to lead performance; Brazil and Russia have already seen Crude Oil’s recovery steer their economies out of recession. Consequently, the Brazilian Real (BRY) and the Russian Rouble (RUB) surged against the USD in the last year – the BRY by 20% and the RUB by 24%.[16] [17] While Russia’s economic prospects are dimmed by geopolitical tensions, the Brazilian economy is thriving under the pro-business, fiscally-sound administration that took office following Dilma Rousseff’s impeachment. In addition, both Brazil and Russia stand to benefit from Trump’s plan to increase infrastructure spending, as it would spur demand for raw material imports.[18] The Indian Rupee (INR) also demonstrated surprising resilience in 2016 in spite of domestic and global disruptions. Onshore liquidity has improved substantially with 80-90% of outlawed notes replaced in recent months.[19] The Indian economy’s 2017 performance will depend on economic progression in a post-remonetisation environment, and its management of the budget deficit. And should the BJP win the upcoming Assembly elections in five key states, the government would be well-positioned to pass reforms that would bolster the Rupee.[20]

The Emerging Market currencies that are most vulnerable this year belong to the smaller Asian economies – Korea, Singapore and Malaysia – given their reliance on globalization, U.S. trade, and thus U.S. macro fundamentals. Moreover, domestic and regional challenges have overshadowed growth prospects in these markets. Overleveraged businesses and households in all three countries portend high exposure to U.S. rate hikes in particular, while hostility from both China and North Korea has heightened geopolitical and investment risk all across the East Asia region.[21] [22] A prolonged bearish stretch is therefore projected for this basket of currencies.

The trade-weighted USD looks set to anchor global financial conditions for the remainder of 2017. As Trump pursues a pro-growth, “America-first” agenda, the Fed’s predicted response of three rate hikes will underpin USD strength. The currencies of economies that are inversely correlated to the USD and U.S. interest rates are most exposed – the JPY, and currencies of the smaller Asian markets. The, MPX and CAD, both dependent on U.S. trade, will also struggle against the USD but could perform against G-10 peers, especially if anti-NAFTA rhetoric fades. Domestically-driven and trade-neutral economies will not be significantly impacted by U.S. macro fundamentals; the BRY, RUB, and INR are the best bet to perform on a relative basis due to robust, organic growth from their economies. Finally, the GBP is still distressed from Brexit proceedings, while the EUR could tumble as upcoming elections have the potential to shake Europe’s political landscape, against an already stagnating economic backdrop. As always, FX performance in developed and emerging markets alike will hinge on whether their economies can both absorb political shocks and respond to macro-economic challenges.


[1] Mutikani, Lucia. “U.S. Retail Sales Rise; Inflation Posts Largest Gain in Four Years.” Reuters. Thomson Reuters, 15 Feb. 2017. Web. 09 Mar. 2017.
[2] Lien, Kathy. “ECB Watch: Will Draghi Help Or Hurt Euro?” Investing.com. N.p., 08 Mar. 2017. Web. 09 Mar. 2017.
[3] Mutikani, Lucia. “U.S. Retail Sales Rise; Inflation Posts Largest Gain in Four Years.” Reuters. Thomson Reuters, 15 Feb. 2017. Web. 09 Mar. 2017.
[4] “Foreign Exchange Outlook.” GLOBAL ECONOMICS & FOREIGN EXCHANGE STRATEGY (2017): n. pag. Scotiabank, Feb. 2017. Web. 9 Mar. 2017.
[5] ibid
[6] “RBC Global Investment Outlook.” THE GLOBAL INVESTMENT OUTLOOK (2017): n. pag. RBC Global Asset Management, 2017. Web. 9 Mar. 2017.
[7] Khan, Mehreen. “‘Desperate Measures’: Analysts React to Mexico’s $20bn Peso Plan.” Financial Times, 22 Feb. 2017. Web. 09 Mar. 2017.
[8] “Foreign Exchange Outlook.” GLOBAL ECONOMICS & FOREIGN EXCHANGE STRATEGY (2017): n. pag. Scotiabank, Feb. 2017. Web. 9 Mar. 2017.
[9] ibid
[10] CANEPA, BALAZS KORANYI and FRANCESCO. “ECB to Sit Tight Ahead of Potential Election Upsets in France, the Netherlands.” The Globe and Mail. N.p., 08 Mar. 2017. Web. 10 Mar. 2017.
[11] Lien, Kathy. “ECB Watch: Will Draghi Help Or Hurt Euro?” Investing.com. N.p., 08 Mar. 2017. Web. 09 Mar. 2017.
[12] “Foreign Exchange Outlook.” GLOBAL ECONOMICS & FOREIGN EXCHANGE STRATEGY (2017): n. pag. Scotiabank, Feb. 2017. Web. 9 Mar. 2017.
[13] “Japanese Yen – Forex Walkthrough.” Investopedia. N.p., n.d. Web. 10 Mar. 2017.
[14] “Foreign Exchange Outlook.” GLOBAL ECONOMICS & FOREIGN EXCHANGE STRATEGY (2017): n. pag. Scotiabank, Feb. 2017. Web. 9 Mar. 2017.
[15] ibid
[16] “Strengthening Ruble Boosts Russian Imports.” RT International. N.p., 08 Feb. 2017. Web. 10 Mar. 2017.
[17] Oyamada, Aline, and Paula Sambo. “Brazil Bulls Who Called Currency Rally Predict More Gains.” Bloomberg.com. Bloomberg, 07 Mar. 2017. Web. 10 Mar. 2017.
[18] “Currencies: Will Trumponomics Echo Reaganomics?” Currency Outlook. Russell Investments, n.d. Web. 10 Mar. 2017.
[19] “Foreign Exchange Outlook.” GLOBAL ECONOMICS & FOREIGN EXCHANGE STRATEGY (2017): n. pag. Scotiabank, Feb. 2017. Web. 9 Mar. 2017.
[20] ibid
[21] Shaffer, Leslie. “Singapore Dollar Hits Weakest in More than Seven Years.” CNBC. CNBC, 20 Dec. 2016. Web. 10 Mar. 2017./.latest_citation_text
[22] Haigh, Adam. “Asia’s Top Performing Currency May Hit Rough Waters.” Bloomberg.com. Bloomberg, 07 Mar. 2017. Web. 10 Mar. 2017.
Kabir Vassanji

Kabir Vassanji

Junior Editor at InPRA
Kabir Vassanji graduated from McGill University in Montreal, Canada, with a degree in Finance and International Business in 2015. He has interned in the fields of wealth management and capital markets, and now works at an investment bank. His areas of interest include finance, economics, technology, and foreign affairs. Particularly of interest is the intersection of finance and macro-economic policy, within his home country Canada, as well as in emerging markets. In exploring these topics with InPRA, Kabir hopes to enhance his writing and research skills to complement his quantitative background.
Kabir Vassanji

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