G10 Forecast Revision - Q1 2018

Print Friendly and PDF

US Dollar (USD)

The US Dollar (USD) has experienced a mixed past few months. The currency clawed back ground against its major peers in September and October, having suffered from a fairly dire first eight months of the year that saw the greenback slump to its weakest position since January 2015 (Figure 1). It has, however, fallen again since November and ended 2017 almost 11% lower than where it began the year against its major peers.

Figure 1: US Dollar Index (January ’17 - January ’18)

 

Captura_de_pantalla_2018-01-08_a_las_10.55.24.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

President Donald Trump’s inability to force through the infrastructure spending last year promised during his election campaign has weighed heavily on the currency, while ongoing international friction with North Korea has far from helped matters. Republicans did, however, take an important step towards passing the tax overhaul in late-November following a Senate vote and President Trump signed into law the GOP’s sweeping $1.5 trillion tax reform bill in December. This entails lower taxes for corporations, while providing tax relief for many in a bid to lift growth in the world’s largest economy.  

The Dollar has, at least, received some support from the growing expectation that the Federal Reserve will continue on its path of monetary policy normalisation by raising interest rates on multiple occasions in 2018. As was universally anticipated, the Fed raised rates for the third time in the calendar year in December, while keeping its expectations for hikes in 2018 broadly unchanged (Figure 2). The median forecast for hikes, as represented by the latest ‘dot plot’, shows that the Fed continues to expect rates to be raised on three additional occasions in 2018 and two in 2019, unchanged from the last set of projections in September. Meanwhile, the statement was little altered from the previous meeting in November. Policymakers continued to cite a strong labour market and growth in both household and business spending.


Figure 2: FOMC ‘Dot Plot’ versus OIS Curve (2017 - 2020)

Captura_de_pantalla_2018-01-08_a_las_10.56.41.png

Source: Bloomberg Date: 07/12/2017

 

Recent economic data out of the US has further cemented the case for higher rates. The US economy expanded by 3.2% annualised in the third quarter of the year, its fastest pace of growth in three years (Figure 3). Encouragingly, the acceleration in growth has been broad based, with strong business investment and robust consumer spending ensuring that the economy withstood the effect of the September hurricanes that many feared would weigh on overall activity.

 

Figure 3: US GDP Growth Rate Annualised (2010 - 2017)

 

Captura_de_pantalla_2018-01-08_a_las_10.57.29.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

The US labour market also showed signs of recovery in November from September’s hurricane induced slowdown. A net total of 228,000 jobs were created, further alleviating any concerns that September’s seven year low nonfarm payrolls number could be symptomatic of a slightly more prolonged period of lower jobs growth. Unemployment of 4.1% is also around the level deemed as full employment by the Fed, while the twelve month moving average of earnings growth remains around its highest level since early-2010.

Core inflation has shown some encouraging signs of an uptrend, rising back to 1.8% in October and 1.7% in November (Figure 4), its highest level since April. Crucially, the Fed’s preferred measure of price growth, the PCE index, has also jumped back to 1.8% in November. A more sustained rebound in this index back above the 2% target level should convince some of the more dovish members on the FOMC the need for multiple interest rate hikes in the US in 2018.

 

Figure 4: US Inflation Rate (2013 - 2017)

 

Captura_de_pantalla_2018-01-08_a_las_10.58.22.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Outgoing Chair Janet Yellen has continued to strike an upbeat tone during her latest communications and we think that another hike in March is highly likely. In our view, the appointment of Governor Jerome Powell as the next Chair of the Federal Reserve to succeed Janet Yellen when her term comes to an end in February should not materially change the pace or timing of interest rate hikes from the FOMC this year. Powell is seen as a generally safe choice whose views on the path of monetary policy are mostly in line with that of Yellen.

Despite narrowing of late there is still a disconnect between the market’s expectations for future hikes and that of the Fed. Financial markets are pricing in just two hikes in 2018, a slower pace than the FOMC’s ‘dot plot’. As financial markets reprice their expectations for Fed hikes, and now that Donald Trump has finally forced through his long awaited tax reform, we would expect to see a rebound in the US Dollar against most major currencies.

Captura_de_pantalla_2018-01-08_a_las_10.59.48.png

UK Pound (GBP)

Sterling has risen fairly sharply against the US Dollar since the beginning of November. The Bank of England’s first interest rate hike in ten years has helped lift the currency to just shy of September’s fifteen month high and the Pound ended last year almost higher 10% versus the greenback (Figure 5).

Currency traders have also begun to take on a generally more optimistic stance over the Brexit process after Theresa May secured a last minute deal in the first round of Brexit negotiations in December. This now paves the way for trade talks to commence in January. There were also suggestions in the last week of November that the UK and EU had come to an agreement over the size of the Brexit bill, which has further fuelled hope of a slightly smoother exit process.  

 

Figure 5: GBP/USD (January ‘17 - January ’18)

Captura_de_pantalla_2018-01-08_a_las_11.01.19.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Meanwhile, the Bank of England voted 7-2 in favour of raising interest rates by 25 basis points back to 0.5% in November, a slightly more comfortable majority than the 6-3 vote that was expected. The committee judged that it was ‘appropriate to tighten modestly the stance of monetary policy in order to return inflation sustainably to target’. The BoE adopted a cautious tone with regards to addition policy tightening with all members agreeing that future interest rate hikes would be both ‘at a gradual pace and to a limited extent’. The bank also said that its economic forecasts were based off just two future interest rate rises over the next three years in order to prevent the economy from running ‘too hot’.

One of the main catalysts for higher rates in the UK is undoubtedly the recent sharp increase in inflation. Headline consumer price growth rose to a five year high 3.1% in November (Figure 6), and could increase even higher before very gradually returning back to the 2% target level.  

 

Figure 6: UK Inflation Rate (2013 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.02.16.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Policymakers in the UK did, however, voice concern over Britain’s decision to leave the European Union, claiming that the Brexit process was already having a ‘noticeable impact’ on the economic outlook. Economic growth in the UK was somewhat disappointing in 2017 and Britain’s economy has been one of the slowest growing of all the G-20 economies. Growth did at least pick up pace in the third quarter of the year, unexpectedly increasing to 0.4% quarter-on-quarter, its highest level since the end of 2016. The central bank modestly lowered its GDP growth forecast this year to 1.6% from 1.7% amid ‘considerable risks’ that remain, including around Brexit. Carney explicitly stated that Brexit would likely be the biggest driver of interest rates.

Despite the Bank of England’s warnings, the ongoing uncertainty from the Brexit negotiations has so far failed to have any materially damaging downside effects on business activity. The latest PMIs have been solid and the crucial services index continues to print comfortably above the level of 50 that denotes expansion, jumping to a much better-than-expected 55.6 in October, its highest level since April. November’s manufacturing index also spiked to a very impressive 58.2, its strongest reading in six-and-a-half years. We reiterate that one of the main stumbling blocks to higher growth in the UK is the current level of negative real earnings growth, given consumption accounts for over two-thirds of overall GDP, which currently stands at -0.7% (Figure 7). This has, however, been driven almost entirely by the inflation pick-up and nominal earnings have remained at a level above 2%.

Figure 7: UK Real Earnings Growth (2011 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.03.10.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

We remain relatively bullish about the prospects for the Pound. Recent Brexit related news has been positive and investors are coming around to the idea of a smoother transitional exit period. Regardless, it will still be some time before we have any concrete details on how the terms of the Brexit deal will affect the UK economy.

We also think the market is underestimating the chances of another interest rate hike from the Bank of England this year. While the BoE is still some way off from joining the Federal Reserve in engaging in a full on hiking cycle, we think that another hike later in 2018 is possible. This is dependent on a marked improvement in overall economic growth, a more sustained rebound in the labour market and data that inflation is showing little signs of returning to target.

Given the somewhat reduced risks of a hard Brexit, and the possibility of higher rates in the UK this year, we think the Pound will continue to remain well supported against its major peers in 2018 and 2019.

Captura_de_pantalla_2018-01-08_a_las_11.03.55.png

 

Euro (EUR) 

The sharp rally in the Euro in 2017 eased towards the back end of last year, with a broad recovery in the US Dollar, renewed political uncertainty in Europe and continued dovishness on the part of the European Central Bank briefly sending the currency to a three-and-a-half month low in November (Figure 8). It did, however, rise back to a four month high in the final week of the year.  

Figure 8: EUR/USD (January ‘17 - January ‘18)

Captura_de_pantalla_2018-01-08_a_las_11.05.44.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

The surprisingly poor showing of Angela Merkel’s CDU Party at Germany’s general election has created renewed political concerns among investors. Merkel fell short of achieving an outright majority in September and failed in talks to form a government with the liberal Free Democrats and Greens. She has also so far been unable break a deadlock in negotiations with the Social Democrats (SPD), which formed a ‘grand coalition’ with Merkel between 2013 and 2017.  

On the monetary policy front, the European Central Bank announced in October that it will be extending its large scale quantitative easing programme beyond the previous December 2017 end date, the third extension since the stimulus measures were launched almost three years ago. The QE programme will be extended by an additional nine months and will now run until at least through September 2018 as the central bank continues its efforts to lift inflation in the currency bloc. This is slightly longer than the six months that the majority of the market had anticipated. The central bank will cut the pace of its asset purchases in half in January from €60 billion a month to just €30 billion (Figure 9).

 

Figure 9: ECB Monthly Asset Purchases (2014 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.06.35.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

President of the ECB Mario Draghi maintained his dovish rhetoric during the latest press conference. Draghi claimed that an ‘ample degree’ of monetary stimulus was still necessary for a build-up in inflationary pressures, even saying that inflation would temporarily decline from current levels towards the turn of the year. He did, however, acknowledge that the ‘recalibration’ of the asset purchasing programme reflected a growing confidence in a convergence towards the bank’s CPI target.

More importantly for currency markets has been the ECB’s recent commitment to keep rates at current negative levels ‘for an extended period of time, and well past the horizon of net asset purchases’. Draghi has also made some relatively downbeat comments on ‘subdued’ inflation levels and the need for ‘sustained accommodation’ in order to push it upwards to the ECB target. The ECB’s heavily scrutinised measure of core inflation, one of the most significant determinants of the central bank’s monetary policy, has continued to print comfortably short of the ‘close to, but below’ 2% target level. Core inflation unexpectedly remained unchanged at just 0.9% in November after investors had eyed an increase to 1.1% (Figure 10), while the headline measure came in at just 1.5%. This closely watched index has now failed to breach the 2% level for the past fourteen years and the chances of it returning back to the ECB’s target any time soon remain remote.

Figure 10: Eurozone Inflation Rate (2013 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.07.33.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

We have, however, seen an impressive recovery in overall economic activity in the Eurozone and the currency bloc’s economy has continued to power ahead so far in the second half of the year. The recent business activity PMIs have been very impressive, suggesting that the Eurozone economy is likely to put in another robust performance in the final quarter of the year. November’s manufacturing PMI jumped to a seventeen year high 60.1, while the services index is around its highest level since 2011. Economic growth of 2.5% year-on-year in the third quarter was also its highest level in six years (Figure 11), with seventeen year high jobs growth and new manufacturing orders suggesting that the economy is firing on all cylinders.

Figure 11: Eurozone Annual GDP Growth Rate (2010 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.08.18.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Even following the recent impressive improvement in economic growth in the Eurozone, it is clear that the European Central Bank remains concerned about persistently below target inflation data. Neither the ECB’s decision nor the communications in October change our view that policymakers in the Eurozone are going to proceed very cautiously given the lack of a pickup in core inflation. Any increases in interest rates, the key to currency movements, look unlikely to occur in 2018 and will most probably be delayed until well into 2019.

In our view, the widening rate differential between that of the US and the Eurozone should pressure the EUR/USD rate lower in the first half of 2018.

Captura_de_pantalla_2018-01-08_a_las_11.09.05.png

 

Japanese Yen (JPY)

The Japanese Yen (JPY) remained within the 110-115 range against the US Dollar throughout almost the entirety of 2017 (Figure 12). The Yen had rallied to its strongest position in ten months in September, although has since lost ground again following renewed divisions among the Bank of Japan’s rate setting committee and the victory of the incumbent Shinzo Abe at October’s general election.

Figure 12: USD/JPY (January ’17 - January ’18)

Captura_de_pantalla_2018-01-08_a_las_11.10.05.png

Source: Thomson Reuters Datastream Date: 02/01/2017

 

Prime Minister Abe’s decision to call a snap election in late-September proved to be the correct one, with his Liberal Democratic Party securing a comfortable two-thirds ‘super majority’ victory. This now looks like ensuring a continuation of his ‘Abenomics’ economic revival plan which involves his ‘three arrows’ of monetary easing, fiscal stimulus and structural reforms.

Policymakers in Japan have continued to maintain its extensive stimulus programme this year, saying at its September meeting that it would take time to achieve the 2% inflation target. There was, however, dissent among the committee with new board member Goushi Kataoka voicing a preference for more aggressive monetary easing. Its so-called “quantitative and qualitative monetary easing with yield curve control” will see the bank purchasing government bonds at an annual pace of 80 trillion Yen in order to maintain a 10 year government yield of around zero. This large scale easing, combined with its negative -0.1% deposit rate, will continue until inflation exceeds the central bank’s 2% target level.

Despite increasing since the back end of last year, inflation in Japan has continued to fall short of its 2% target level. The main rate of inflation slumped to just 0.2% in October, although has since picked up again to 0.6% (Figure 13). This is still comfortably short of the one percent mark that it has failed to breach in every month since the removal of the sales tax hike from the index in 2015. The core measure, which excludes fresh food, also remained mostly unchanged at 0.9% and the Bank of Japan has been forced to push back its forecast for reaching its 2% target. Policymakers now expect price growth to increase towards 2% in 2019/20 rather than the 2018/19 previous estimate.

Figure 13: Japan Inflation Rate (2010 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.10.59.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

The Japanese economy has continued to expand at a moderate pace, with growth for the three months to September coming in at an annualised 2.5% (Figure 14), following the largest downward revision since 2010 in Q2. The Japanese economy did, at least, register its seventh consecutive quarter of growth for the first time in sixteen years. The country’s manufacturing PMI is also at its highest level since the beginning of 2014, services activity rose to a two year high in October, while retail sales increased in all but one month in 2017.

Figure 14: Japan GDP Growth Rate (2011 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.11.45.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Following recent communications from the Bank of Japan, and the still well below target inflation data, we think that the central bank looks set to continue to maintain its aggressive monetary policy stance in 2018, particularly after Abe’s recent election victory. Given this still loose monetary policy stance we continue to forecast a gradual depreciation of the currency from current levels against the US Dollar.  

Captura_de_pantalla_2018-01-08_a_las_11.12.45.png

Swiss Franc (CHF)

The Swiss National Bank (SNB) has finally got its wish for a weaker Swiss Franc (CHF) in the past few months, with the currency depreciating sharply against the Euro since the summer. The Franc depreciated to its weakest position since the removal of its Euro cap in January 2015 in December and lost more than 9% of its value in 2017 (Figure 15). The rapid decline in the currency follows renewed dovishness on the part of the Swiss National Bank (SNB) and an unwinding of safe-haven flows, causing CHF to be one of the worst performing G10 currencies against the Euro in the second half of the year.

Figure 15: EUR/CHF (January ’17 - January ’18)

Captura_de_pantalla_2018-01-08_a_las_11.13.51.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

For its part, the SNB has also remained one of the more dovish G10 central banks, even amid a general improvement in global economic conditions. At its September meeting, the Swiss National Bank abandoned its mantra that it has adopted ever since the cap removal that the Franc is ‘significantly overvalued’, instead calling the currency ‘highly valued’. However, it did not signal a departure from its ultra-loose monetary policy stance, retaining its negative interest rate and reiterating that it stands ready to intervene in the foreign exchange market.

The SNB was active in the FX market earlier in the year, intervening through buying foreign currency in order to weaken the Franc. Currency intervention remains a viable policy tool for the central bank, although the recent weakness in the Franc should limit the need for it. The re-weighting of the SNB’s exchange rate index back in March reflecting a weaker CHF than originally expected may also lessen to need for currency intervention. SNB Vice President Fritz Zurbruegg defended the use of negative interest rates and currency intervention in an interview in October.

The weaker currency has begun to filter its way through to higher inflation, which should lessen the need for the central bank to ease monetary policy further. Headline inflation rose to 0.8% in November, its highest level since 2011 (Figure 16). Core inflation has also shown some encouraging signs of an uptick, increasing to 0.6%, having been below zero in every month for almost two years up to February.

Figure 16: Switzerland Inflation Rate (2010 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.14.33.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Economic growth in Switzerland has improved in the past few quarters, increasing to 1.2% year-on-year in the three months to September (Figure 17). A modest acceleration in the final quarter of the year looks on the cards following an impressive rebound in manufacturing activity. The manufacturing PMI in Switzerland has continued to trend higher in the past few months, posting its strongest reading in six years in October, rising to 62.0. This is now considerably higher than the long term average of 53.8. Wage growth has also improved in the past few months, rising to a near three year high 0.7%, which should support consumer spending.  

Figure 17: Switzerland Growth Rate (2010 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.15.13.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Recent communications out of the Swiss National Bank suggest that policymakers in Switzerland remain opposed to a strong Franc. We think the SNB will continue to intervene should we see another sustained appreciation of the currency. However, the sharp depreciation in CHF and likelihood of an imminent tightening in monetary policy by the European Central Bank should limit the need for additional stimulus from the Swiss National Bank. On the other hand, Switzerland’s massive current account surplus and the likely absence of the SNB from the market will prevent a significant depreciation of the Swiss Franc from current levels. We therefore revise our forecasts higher, and forecast a stable CHF against the Euro around the 1.14 level.

Captura_de_pantalla_2018-01-08_a_las_11.16.00.png

 

Australian Dollar (AUD)

The Australian Dollar (AUD) had a very impressive year up until early September, strengthening to its highest level in two-and-a-half years against the US Dollar following an increase in commodity prices. However, the currency retraced much of its gains in the three months through to mid-December on renewed dovishness on behalf of the Reserve Bank of Australia (RBA).  

Figure 18: AUD/USD (January ’17 - January ’18)

Captura_de_pantalla_2018-01-08_a_las_11.16.48.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

The Reserve Bank of Australia has continued to keep its monetary policy steady for over a year and investors have pushed back their expectations for the next interest rate hike. At its November meeting, the RBA cut its forecast for economic growth and now expects to falls short of its inflation target through to mid-2019, suggesting it will be in no rush to raise interest rates. The statement voiced general optimism towards the growth outlook, although there were little signs that the central bank is in a rush to raise rates anytime soon.  

The central bank’s reluctance to increases rates has come off the back of the Australian economy expanding at a much slower pace than hoped in the first half of 2017. GDP expanded by just 1.8% in the second quarter of the year, following similar growth in the first quarter, although has since picked up to 2.8% in Q3. Net exports were stronger than expected, although weak household income growth continued to weigh on consumer spending. Wage growth is near a record low level and real earnings growth is barely positive, having fallen into negative territory for the first time since the second quarter of 2014 and only the fifth occasion since the financial crisis earlier this year (Figure 19). The jobless rate is, however, at its lowest level since 2013, which should provide some encouragement to the RBA.

 

Figure 19: Australia Real Earnings Growth (2002 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.18.58.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Consumer prices are expected to remain subdued this year with the RBA warning that the strong AUD would result in a slower pick-up in inflation than forecast. The headline measure of inflation fell again in the third quarter of the year to 1.8% and has been below the RBA’s 2-3% target range in all but one month since late-2014. Core inflation has also continued to disappoint, coming in at 1.8% for the third consecutive month and printing below target since the end of 2015. The RBA has now lowered its inflation forecast to just 2% by the end of 2019.

Figure 20: Australia Inflation Rate (2006 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.19.41.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Following the slowdown in inflation, and recent dovish comments from the Reserve Bank of Australia, financial markets are now not pricing in an interest rate hike at all in 2018. While the prospect of stable policy in Australia for the foreseeable future limits upside potential for the currency, an expected increase in commodity prices, of which accounts for around 70% of overall Australian exports, should provide decent support for the Australian Dollar. We therefore continue to forecast a relatively stable Australian Dollar against the USD just below current levels.

Captura_de_pantalla_2018-01-08_a_las_11.20.20.png

 

New Zealand Dollar (NZD)

The New Zealand Dollar (NZD) has fallen relatively sharply since the end of July, slipping to a one-and-a-half year low against the US Dollar in November (Figure 21). The Reserve Bank of New Zealand’s reluctance to raise interest rates, a broadly stronger USD and a sharp drop off in global dairy prices since the beginning of October saw the currency lose almost 10% of its value against the greenback in the four months through to early December alone.  

Figure 21: NZD/USD (January ’17 - January ’17)

Captura_de_pantalla_2018-01-08_a_las_11.21.11.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

The Reserve Bank of New Zealand has held its main interest rate steady at 1.75% since the end of 2016, although it did take on somewhat more of a hawkish stance at its November meeting. The RBNZ continued to state that monetary policy will remain accommodative for a ‘considerable period’, although it opened the door to a sooner-than-expected hike by bringing forward its projections for a rate increase to the second quarter of 2019 from the third. It has continued to claim that there was no need to cut interest rates again given inflation was likely to pick-up.

Consumer price growth has shown some encouraging signs in the past few months, having remained stuck below 1% for over two years through to the end of 2016. Headline inflation came in at 1.9% in the third quarter, just below the central bank’s target.   

Figure 22: New Zealand Inflation Rate (2009 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.22.00.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

The New Zealand economy has also slowed this year, pushing back expectations for the next interest rate hike. Growth slowed to 2.7% year-on-year in the third quarter of 2017, its slowest pace of expansion since early-2014. Industrial production growth has been more-or-less flat so far this year, while business confidence has slipped into negative territory for the first time in two years. Acting Governor of the RBNZ Grant Spencer struck a confident note on the growth outlook in November, noting that an improvement in terms of trade, currency weakness and fiscal expansion would help lift growth.

New Zealand’s impressive labour market performance should also help economic activity pick up pace next year. The jobless rate fell again in the third quarter of 2017 to an 8 year low 4.6% (Figure 23), while average earnings growth has begun to pick up pace again since the beginning of 2017 and is now back above 2%.

Figure 23: New Zealand Unemployment Rate (1998 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.22.41.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Recent communications out of the RBNZ confirm our expectation that the central bank will likely keep its main interest rate on hold for the foreseeable future, likely until 2019. The prospect of stable monetary policy from the Reserve Bank of New Zealand and rising interest rates by the Federal Reserve in the US should, in our view, lead to a modest depreciation of NZD against the US Dollar, followed by a stabilisation. The main risk to this outlook would be a faster than expected drop in New Zealand real estate prices, but we think that the still very low level of rates prevailing makes this a low probability development.

Captura_de_pantalla_2018-01-08_a_las_11.23.26.png

 

Canadian Dollar (CAD)

Following a very impressive second and third quarter of the year, the Canadian Dollar (CAD) lost ground again versus the US Dollar in the three months from early September (Figure 24). A string of disappointing economic data releases and the fading likelihood of another interest rate hike by the Bank of Canada sent CAD to its lowest position in over five months in December.

Figure 24: USD/CAD (January ’16 - January ’17)

Captura_de_pantalla_2018-01-08_a_las_11.24.18.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

The Bank of Canada (BoC) became the first G10 central bank, with the obvious exception of the Federal Reserve, to begin normalising monetary policy in July since the sharp decline in oil prices forced global inflation lower in 2014. The BoC followed up their July hike with an additional 25 basis point increase in the main rate to 1% in September, with investors quick to begin pricing in another rate increase before the end of the year. However, expectations for the next hike were pushed into 2018 after the release of a string of disappointing economic data releases.

Canada's economy expanded by a whopping 4.5% in the second quarter (Figure 25), its fastest pace of growth since the end of 2011 and best first half performance in fifteen years. An impressive bounce in exports and household spending, accompanied by solid business investment and government spending made the economy the fastest growing of all the Group of Seven countries.

Figure 25: Canada GDP Annualised (2009 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.25.07.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Weaker exports meant that growth slowed to just 1.7% in the three months to September, although recent data for the final quarter has picked up pace again. Retail sales growth smashed expectations in October, jumping 1.5%, its fastest pace in almost a year. Canada’s labour market has also shown solid signs of improvement. The economy created a massive 79,500 jobs in November, its most in a single month since 2012. The jobless rate has also fallen sharply to a nine year low 5.9%. This improvement in economic conditions, and a recent jump in headline inflation to 2.1% in November, has reigniting hopes of more BoC rate hikes in the first half of this year.

 

The Canadian Dollar should also continue to be supported by the recent rebound in oil prices. Brent crude oil rose back above $65 a barrel in December and has now risen by over 40% since the summer (Figure 26). CAD has followed a fairly similar path to that of oil prices, given the commodity accounts for around a quarter of Canada’s overall export revenue.

Figure 26: CAD/USD vs. Crude Oil Prices (2014 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.25.42.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Following the improvement in economic activity in Canada and recent jump in inflation still, we think another interest rate hike from the Bank of Canada is likely in the first quarter of the year. We think that the Trump administration is unlikely to dop anything particularly disruptive about NAFTA. Absent that risk, the Canadian Dollar is poised to benefit from faster interest rate increases from the Bank of Canada, US fiscal stimulus and higher oil prices. We expect it to be one of the best performing currencies into 2018.   

Captura_de_pantalla_2018-01-08_a_las_11.26.23.png

 

Swedish Krona (SEK)

After an impressive second quarter, the Swedish Krona (SEK) lost ground against the Euro again in September, with an underwhelming October inflation release strengthening the case for a dovish Riksbank and sending the currency to its lowest level since November 2016 (Figure 27). The far stronger November inflation report has so far done little to help the currency rebound.

Figure 27: EUR/SEK (January ’17 - January ’18)

Captura_de_pantalla_2018-01-08_a_las_11.27.26.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

The Riksbank has long been one of the more dovish central banks among the G10 economies. The central bank has maintained its main interest rate deep in negative territory at -0.5% since early-2016, while keeping its large scale quantitative easing programme steady since April through to the end of last year. At its December meeting, policymakers reiterated their message from October, and said that the repo rate would remain at its current level until mid-2018, before slowly increasing. The asset purchase program was not extended, but maturities and coupons from already purchased debt will be reinvested. Two of the five board members, however, registered a dissent saying the decision to reinvest should have been delayed.

The reluctance of the Riksbank to begin tightening monetary policy follows the prolonged bout of disappointing news on the inflation front. Inflation did at least show some encouraging signs in 2017, rising to a six year high 2.2% in July. Consumer price growth has since retreated again, coming in at 1.9% in November. The core measure also fell short of expectations after slipping to just 1.8%, its lowest level since March. This downturn underpinned concerns that above target inflation in the past few months was indeed temporary and that it could take a number of months for price growth to return back to the central bank’s target level.  


Figure 27: Sweden Inflation Rate (2013 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.28.17.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Encouragingly, the economy has shown some steady signs of an uptrend in 2017. Sweden’s economy expanded 2.9% year-on-year in the third quarter, its fastest pace of growth since the second quarter of 2016, although this was slightly lower than forecast. Domestic demand remains robust with retail sales expanding in seven of the past ten months. Sales also posted its largest year-on-year increase in almost twelve months in September, despite wage growth remaining negative throughout much of 2017 (Figure 28). Industrial production growth has so far been around its highest level since 2011 this year, while the manufacturing PMI has been above 60 throughout much of the calendar year, well above the level of 50 that denotes expansion.

Figure 28: Sweden Average Earnings Growth (2011 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.28.58.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

We think that economic fundamentals in Sweden are improving and the country is in a much healthier position than it was when the Riksbank extended its quantitative easing programme back in April. The central bank remains on course to begin raising interest rates in mid-2018, much sooner than the ECB, while our view that the Riksbank would not extend its QE programme beyond December has been vindicated.

We are of the opinion that the recent deprecation of SEK has left the currency execeivesly weak and we continue to expect an appreciation of the Krona against the Euro in 2018, albeit we revise our forecasts higher to reflect recent weakness in the currency.

Captura_de_pantalla_2018-01-08_a_las_11.29.42.png

 

Norwegian Krone (NOK)

The Norwegian Krone (NOK) had an impressive third quarter of the year, holding its own against a broadly stronger Euro, while appreciating by around 5% versus the Dollar in the three months to the end of September. The currency has, however, recommenced its downward trend since the beginning of October, slumping to its lowest level since 2009 versus the common currency (Figure 29).

Figure 29: EUR/NOK (January ’17 - January ’18)

Captura_de_pantalla_2018-01-08_a_las_11.30.42.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

Recent weakness in the Krone has come off the back of another disappointing downturn in inflation in Norway that reinforced expectations that Norges Bank will be in no rush to change its policy stance. Having increased to an eight year high in 2016, headline inflation in Norway has been on a sharp downward trend in the past year, slumping to five year low 1.2% in October. Core inflation also remains stuck at just 1.1% and is comfortably below Norges Bank’s 2.5% target.

Despite the inflation slowdown, Norges Bank changed its tone at its December meeting, striking a hawkish note and bringing forward expectations for interest rate hikes. It noted spare capacity in the labour market, while claiming that the economy was facing headwinds from a recovering offshore oil and gas sector. This hawkish rhetoric suggest that tighter policy could be on the cards sooner-than-expected.

Following the latest bout of weak inflation data, we’ve seen somewhat of a divergence between the Krone and global oil prices in the past few months. The recent sharp uptrend in oil has, as yet, not filtered its way through to a stronger NOK. Brent crude oil prices have been on a steady upward trend since June, rising sharply by over 40% from less than $45 a barrel to more than $63 a barrel. NOK is generally heavily correlated with the evolution of oil prices and the two have historically followed a very similar trend given oil accounts for a very sizable two-thirds of the country’s overall export revenue.

Figure 30: NOK/USD vs. Crude Oil Prices (2011 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.31.42.png

The weak inflation dynamics and higher oil prices has helped, in part, to lift growth in Norway. The economy had a very impressive third quarter of the year, growing 0.7% quarter-on-quarter and by 3.2% on a year previous, its fastest pace of annual growth since early-2014. Retail sales growth was solid throughout much 2017, while tourism receipts have picked up. Manufacturing production is also back into positive territory this year for the first time since 2015, while output in the industrial sector jumped by a staggering 12.3% in September, its fastest pace since the beginning of 2012. Business confidence is also around its highest level in three years, which would suggest a further acceleration in growth may be on the cards in the third quarter.

Figure 31: Norway Annual GDP Growth Rate (2008 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.32.17.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

We think that the Norges Bank decision to bring forward its schedule of hikes in 2018 is quite significant. The recent depreciation of NOK against the Euro has been excessive and not warranted by the relatively solid economic fundamentals in Norway. An undervalued Krone, strong economy and the recent bounce in oil prices should, in our view, allow room for gains in NOK against the Euro in 2018.

Captura_de_pantalla_2018-01-08_a_las_11.32.58.png

 

Danish Krone (DKK)

The Danish National Bank (DNB) has continued to have no trouble in maintaining the Danish Krone’s peg of 7.46 DKK to the Euro in the past few months. The DNB intervenes in the currency markets using its foreign exchange reserves on a regular basis in order to limit fluctuations around this rate.

Foreign exchange reserves in Denmark have remained stable this year, suggesting there has been very limited speculative pressure on the currency. FX reserves fell slightly to 464.3 billion DKK in September with the central bank claiming that it did not intervene in the foreign exchange market (Figure 32). Even following recent intervention, foreign exchange reserves still only equate to just 20% of Denmark’s overall GDP, with reserves now 40% lower than their peak following the removal of the Swiss Franc’s Euro cap in January 2015.

Figure 32: Denmark Foreign Exchange Reserves (2012 - 2017)

Captura_de_pantalla_2018-01-08_a_las_11.34.08.png

Source: Thomson Reuters Datastream Date: 02/01/2018

 

In order to deter speculative bets on the currency, the Danish National Bank has maintained its interest rate deep in negative territory at -0.65%, having held its policy steady since January 2016. Recent communications from the central bank suggest that rates will remain negative for the foreseeable future, although there may be some room for rates to be raised in order to alleviate pressure on an already overheated housing market. Governor Rohde has acknowledged as much by claiming in October that “higher interest rates are likely to come with a robustly improving macro environment”. Broad Euro strength in 2017 should provide additional room for the DNB to normalise policy in the coming months.

The Danish National Bank has continued to reiterate its desire to maintain its peg against the Euro, claiming that they have limitless scope to alleviate appreciating pressure and deter another speculative attack on the currency. We think the still negative interest rate spread with the Eurozone and comfortable level of FX reserves in Denmark should allow the DNB to maintain the existing EUR/DKK peg at the 7.46 level for the foreseeable future.

Captura_de_pantalla_2018-01-08_a_las_11.34.47.png

 

Have more questions? Submit a request