2016 has seen no shortage of seismic events that have triggered tremendous volatility across global markets from forex to equities to commodities.
Against the backdrop of 2016’s political earthquakes and sluggish global economic growth, here are ThinkMarkets’ projections for the currency market in the year 2017.
What does 2017 have in store for the currency markets?
Having just revised their projections for real GDP growth upwards from 1.2% to 1.5%, the Bank of Japan (BoJ) has removed expectations of further easing and, more specifically, puts a floor on rates at -0.1%. As inflation remains low, there is little reason to expect a rate hike in 2017.
The weaker yen has boosted exports already and, if global demand continues to pick up this year, this could translate to higher domestic growth and inflation. Only then would a rate hike be back on the cards.
Overall, we expect USDJPY to be trading higher at the end of 2017 although, with such a strong rally occurring in Q4 2016, then a necessary correction is due likely sometime in the first half of the year.
The European Central Bank (ECB) extended its quantitative easing (QE) programme to September 2017 at their last meeting. ECB President Mario Draghi doubts that inflation would remain if they were to stop QE, so the extension conveniently allows the ECB to see how global reflation plays out and whether it will seep into the Eurozone.
Therefore, we do not see 2017 as being a particularly active year for the ECB, particularly when the Federal Reserve are supposedly on a solid hiking path of their own. However, they may become more vocal about tapering their QE programme if data continues to pick up. Germany, who have never been comfortable with the programme would likely step up pressure on ECB to commit to tapering.
The combined effect of higher rates from the Fed and political uncertainty are likely to keep the euro under pressure—we see a move to below parity with the US dollar as more than achievable.
The Fed surprised to the upside with their projections following their 2016 December meeting, resulting in an even stronger USD and higher global inflation expectations.
For every winner, there is a loser but, in the Fed hike’s case, a higher US dollar could have a profound effect on US politics, hamper exports and spark a series of defaults in emerging economies.
A stronger US dollar could also trigger another trade war between the US and Asia, which is arguably already underway with China’s controlled devaluation. If China continues to allow the yuan to slide whilst then Fed raises rates, then Asian trade partners are likely to continue following suit.
The People’s Bank of China (PBOC) is likely to continue allowing the yuan to weaken against the greenback at a controlled pace. Had it not been for PBOC’s positive interventions (which slowed the yuan’s decline) then USDCNH would be trading much higher than it is today.
With Asian economies being so deeply intertwined, their currencies are also closely linked so as to remain competitive with one another. Broad weakness across Asian currencies is therefore likely to follow the continued weakening of the yuan throughout 2017.
GDP growth has remained steady at 6.7% for the past three quarters and, taking the rising PMI data and industrial production into account, there is an argument for GDP growth to remain supported, or even improve, in 2017.
China’s infrastructure spending may provide further support for growth, as this can take much longer time to show up in the economy compared with the PMIs, but their effects last several years.
Reserve Bank of Australia (RBA) rates sit at historic lows of 1.5% and, although minutes following their 2016 December meeting suggest that this will be it for now, there are risks for further easing.
The higher Fed trajectory is helping weigh the AUD down but another rate cut cannot be ruled out until domestic inflation lifts. Q4 2016 GDP (following a contraction in Q3), employment and inflation will be the key indicators to watch in Q1 2017 to indicate odds of a rate cut in Q2 of this year.
RBA are concerned that household borrowing will continue to surge with low rates and is something they “will continue to monitor,” so if domestic conditions do not pick up and borrowing cools, the door is open to another cut sooner rather than later.
Regardless of any cut, the AUD is likely to remain under pressure from the yield differential between the USD and AUD. This will only widen if the Fed continue to hike and increase their hawkish outlook, sending the Australian dollar and fellow export and Asian currencies lower.
Matt Simpson is a Senior Market Analyst at ThinkMarkets.com
Also, read more about why you need to be cautious about the 2017 commodities & stock market!