Elizabeth Belugina, the Head of Analytical Department at FBS
2016 was a year of big political shocks. We will remember this year by the Brexit vote and Donald Trump’s victory in the US presidential elections. Opinion polls failed to predict the correct outcome of these events. It’s also interesting how the market reacted to the news: British pound has remained under pressure up to this moment despite recovery in the UK stocks, while in America the US dollar reversed upwards within hours and then kept appreciating.
There are reasons to believe that heightened volatility will continue in 2017. After all, there will be a lot of political risks, primarily in Europe: the Dutch election in March, France’s election in April and the German one in the second half of the year. The main source of concerns is the risk that populist parties, which are against the euro, will rise to power. It’s quite natural that after political surprises of 2016 traders will be pricing in the negative outcomes in advance. This means that the outlook for the euro isn’t particularly bright, at least until summer. Later the potential tapering and end of the European Central Bank’s quantitative easing program should help the single currency find the bottom. The odds are that EUR/ USD will visit parity and maybe sink a bit lower.
Before we get deeper in our suggestions about 2017, let’s review the themes and trends of 2016. As we’ve already pointed out, one of them was represented by political shocks. What are the others?
First of all, major central banks are evidently running out of monetary tools to encourage economic growth and inflation. The regulators have been fighting this battle since the global financial crisis. This led to competitive devaluation if currencies, known as “currency wars”. Yet, everything has its limits, and we are now hearing here and there about not monetary, but fiscal stimulus. In other words, governments and not central banks will likely play the leading role in supporting domestic economies. It surely doesn’t mean that we will no longer pay attention to banks’ meetings, but the pressure will probably lift off from the regulators. This, in turn, will improve the market’s growth and inflation expectations. Actually, such trend has begun in December. The better the expectations, the better the market’s risk sentiment. As a result, higher-yielding assets like stocks and oil are in bullish trend, while safe havens like gold and Japanese yen, on the other hand, are on the downturn.
Currencies of countries with brightest economic prospects are expected to benefit. One of such currencies is the US dollar. Traders are currently quite positive about American economic outlook. The prevailing opinion is that business will flourish during “Trump-onomics”. Because of such mood, the US dollar, the key Forex currency, has managed to reach its highest level since 2002.The big question how is how Trump will act. Some of his campaign promises, like building a wall between the US and Mexico, were controversial. Yet, it will ultimately come down to whether fiscal stimulus is introduced and how large it will be. Stimulus would mean stronger economy and make the Federal Reserve proceed with the planned rate hikes. Now the FOMC members foresee 3 rate increases in 2017, and we’ll see how the things go. All in all, the US dollar will have a trump card in comparison with the rest of the major currencies because of monetary policy divergence between America and other developed nations. At the same time, having gained nearly 10% since August, the greenback should have some difficulties in maintaining such immense bullish momentum. If Trump disappoints, the bullish trend may even change, as the market’s positioning has become too stretched. Note that expensive USD might raise the Fed’s concerns making the regulator rein in the rate hikes. All in all, we probably won’t see a single trend for both the greenback and other currencies in 2017: the first 6 months may be pretty different from the second 6 months.
British pound will remain affected by the Brexit uncertainty in the first quarter of the year. For now, the legal issues of who will trigger the UK departure from the European Union are being discussed. Will it be a hard Brexit or soft Brexit? Will the process start in 2017 or later? Until we find out the answers to these questions, it will be hard for the sterling to pick a long-term direction. If the UK Supreme Court says that British government can trigger Brexit, it will be negative for the pound. If the Court rules that the government must seek parliamentary approval, the Brexit process will be definitely delayed beyond March 2017 – something that will spur the pound’s growth. The Bank of England says that its action will depend on the dynamics of British economy – it is ready both to cut and raise interest rates. All in all, British currency has support at 1.2000. If the bears succeed in breaking it, GBP/ USD will enter levels unseen for a couple of decades. If Brexit goes relatively smoothly and economic figures don’t disappoint, the undervalued pound should be able to recover some of the lost ground.
Demand for the Japanese yen will likely remain on the downside in 2017, as the Bank of Japan turned to a new type of monetary policy and began targeting the yield curve. As a result, we expect bullish bias for USD/ JPY with targets around 125.85 and 130.00. At the same time, there will surely be moments of risk aversion (remember all the European elections coming?), and the yen should feel stronger during these moments.
Australian currency looks vulnerable as we head into 2017. Problem #1 is China, Australia’s biggest trade partner. The past year was not easy for Chinese financial markets: the yuan and the stocks made the biggest declines in several years. The year of 2017 poses risks related to capital flight and China’s high debt levels. In addition, there are dismal domestic factors: mining boom is no longer helping Australia, the nation’s GDP contracted for the first time in 5 years and its labor market looks grim. The market will likely expect the Reserve Bank of Australia to cut rates in 2017, and these expectations will do the Aussie no good. Watch the levels of 0.6850 and 0.6500 on the downside. Some help from commodity market may come to the Aussie at the beginning of the year.
Oil prices hit the lowest levels since 2003, but after that managed to bottom in 2016. The Organization of petroleum exporting countries (OPEC) did manage to increase confidence in the market. Crude will likely stabilize near $50, at least in the first half of 2017. However, the advance doesn’t seem sustainable as higher prices will make US shale producers return to the market, while the OPEC has a long history of breaking its promises.
Despite the recent decline, gold still finished 2016 above the opening level. From a technical perspective, the precious metal still looks bearish on the monthly chart. We don’t see a buying signal now, but suggest to monitor this market closely as there should be a point in 2017, when investors turn to gold as a safe haven a refuge from inflation.
US stocks didn’t divert from their long-term uptrend. The lack of any meaningful correction in equity markets has worried many traders in 2016. Taking into account the current optimism about the US economy, it’s still very dangerous to short this market. The best solution is to invest in the sectors favored by Trump, such as infrastructure. Health care and pharmaceuticals should also benefit, if there is a restructuring or abandonment of Obamacare.
Finally, it’s necessary to point out that whatever happens, traders should be prepared. Don’t forget about risk and money management tools as they represent the best way to make sure your money is safe and sound.