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2018 Short-Run USD Strength

 

 

The Pound initially recovered its post-Christmas losses this morning. Moreover, marginal volatility appears to have returned to foreign exchange markets. On the final trading day before 2018, the EUR-USD currency cross continues its impressive attempt to retest 1.20. The currency pair broke this level in September, and presently trades just 8 pips short of the milestone. The present range sees the Euro trading at its highest value against the Dollar for almost three years. On a trade-weighted basis, the Dollar has concluded its worst year since 2010, with the Euro boasting its best performance this decade. Despite being enveloped within a weak post-Brexit paradigm, Sterling has not performed too badly in 2017.

 

 

 

Sterling Briefing: Confined Hawkish Brexit Attitudes

 

 

Sterling’s appreciation this morning has been largely unilateral, pervading across each of the G10 currencies. The re-balancing has provided a plethora of conjectural, post-hoc explanations. However, the appreciation appears once again to be little more than a few big players in a low liquidity market, operating with a currency that has become under-valued in the ultra-short-run.

 

International investors are being drawn to the UK market by the over pricing of Brexit uncertainty. However, the attraction appears to be largely limited to the acquisitions space. The prices of assets is being excessively suppressed to account for the uncertainty of Brexit. However, this revelation shows no evidence, either formally or informally, of spilling over into the currency markets. The absolute volume of acquisition deals is insignificant enough to alter the aggregate demand for the Pound and thus raise its equilibrium value. What would be required instead is the extension of optimism to high volume FX firms.

 

There remains upside potential for the Pound Sterling in 2018, especially if a threshold of Brexit progress is achieved that will facilitate a rise in confidence. However, whilst I do believe 2018 holds considerable and underestimated upside potential to the Pound, the undeniable dynamic of ‘nothing is agreed until everything is agreed’ will continue to diminish the significance of tangible Brexit progress.

 

 

 

 

Euro Briefing: Macron’s Reform:

 

 

Market commentators are asking the wrong questions. Inevitably, they are therefore reaching the wrong conclusions, with potentially devastating results for the valuation of the 2018 Euro. Macron’s reforms are being praised by economists for providing the potential for long-run economic growth. Be this justified or erroneous, this variable is insignificant in comparison to the attitude of the reforms with respect to the Euro.

 

French President Emmanuel Macron was a centrist candidate in the recent elections with one key differentiating factor; an infatuation with Europe and campaign image dichotomous to that of far-right and anti-Eurozone candidate, Marine Le Pen. The series of particularly pro-European reforms delivers considerable value to the Euro in light of one of the biggest political risks of 2018: Italy.

 

The Italian elections, scheduled for 4th March, are being framed by the very same economists and political risk analysts as a significant threat to the stability and unity of the Eurozone. Having a systemically pivotal Eurozone member off-setting this risk with leverage within the Council should be valued higher.

 

 

 

Dollar Briefing: Tax Insight

 

Tax reform is framed as mildly positive for the economic outlook of the United States, despite presenting a significant challenge to Federal fiscal responsibility. The positive economic outlook will provide support for the Dollar, however, there is a more tangible effect: the immediate (Q1) repatriation benefit from tax relief will see a considerable increase in the demand for Dollars. However, the wider 2018 consensus is for a bearish Greenback.

 

 

 

Christmas Turkey:

 

The Turkish Lira lost in excess of 16% against the US Dollar between September and December, only stemmed this month by systemic Dollar weakness. The devaluation was supported by President Erdogan’s controversial reforms and deteriorating tolerance on the international stage, shown by the US suspension of visa-relationships. The Christmas period has, however, seen visa agreements return, restoring over 1% of the Lira’s value. USDTRY = 3.791.

 

 

Discussion and Analysis by Charles Porter

 

 

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Italian Elections Ahead

The forex market this morning has largely extended the trends that began yesterday: the US Dollar continues to shed considerable value; the Euro appears stronger against most of its G-10 counterparts; and the Pound’s performance is highly mixed. This morning, Italian Prime Minister Paolo Gentiloni accelerated the aggregated political risk surrounding the Euro. The Italian elections are of high salience to Italy, and the Eurozone in general. These elections, within a founding member of the Eurozone, will add uncertainty to the single currency. Despite this morning’s reminder, the Euro has largely retained yesterday’s turn of strength, accelerating up at 1.1948 against the U.S. Dollar.

 

 

Sterling Briefing: Davis Looks On

 

David Davis has most likely had a rather unpleasant Christmas. Following criticism throughout December and late 2017 for a lack of preparation and forecasting on Brexit, the secretary of state and government has released 850 pages of documents detailing is sector by sector Brexit analyses. Unfortunately for the cabinet member, the publication offered little respite to Davis’ situation.

 

Sterling markets have been hindered by a lack of confidence in the institutional capabilities of Westminster and the incumbent Conservative government. The UK government started on the back foot in Brexit negotiations having failed under David Cameron to plan for the eventuality of a Leave majority. The publication was void of any market sensitive information according the Chair of the ‘Exiting the Union Committee’ and MP, Hillary Benn. Therefore, the market attention to the publication was minimal, leaving Sterling to have an ambiguous, yet pessimistic, post-Christmas performance.

 

What remains important, however, is a weakening of the political stature and security of the member of parliament. The publication, whilst substantive, failed to placate Brexit critics or act as a bargaining chip within European institutions. Moreover, the documents contained little information or support for industries of systemic national important. Specifically, the UK’s prized, and most Brexit-exposed, financial services and banking sector found little solace in the generalized remarks of the report. Developing the challenge to Davis, it is reported today that European institutions, and Davis’ counterpart Michel Barnier, are looking to sideline the UK’s chief negotiator within talks.

 

 

 

Euro Briefing: Italian Uncertainty

 

First the pro-independence success within regional elections in Catalonia and now the acceleration of Italian uncertainty. The end of 2018 is generating numerous political obstacles to Euro strength. However, the single currency refuses to budge from its strong position, particularly versus the US Dollar and the Pound Sterling.

 

Italian elections have been a certainty for some while; the mandate for the present government is expiring. However, this morning saw an affirmation of the nationwide elections from incumbent Prime Minister, Paolo Gentiloni. Having survived French and (just about) the Dutch and German elections, the next hurdle is Italy. Far right and populist movements are incredibly threatening to the Euro and European project. Italy has had one of the most severe and sustained recessions following the sovereign debt crisis, making it highly susceptible to a result that may upset 2017’s equilibrium.

 

 

 

Dollar Briefing: Gains eliminated

 

Early December delivered a forecasted and considerable unilateral appreciation of the US Dollar. The currency gained a little over 1%, driving the EURUSD rate below 1.175 for the first time in over one month. However, since mid-December, the Dollar has relinquished this ground, ending up down 0.35% for the month. The concomitant weakness of Sterling is preventing full gains from being realized within the cable rate.

 

 

 

Boring 2017:

 

It’s official. 2017 has been the most boring year since financial volatility instruments began. Despite idiosyncratic cases of movement and excitement, general volatility, for example that measured within the US S&P 500, ‘VIX’ instrument, is at an all time low. The volatility within currency markets has also been underwhelming. As we look towards 2018, higher growth, and normalising monetary policies, volatility could creep into the market.

 

 

 

Discussion and Analysis by Charles Porter

 

 

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2018 Currency Outlook

Following Christmas, currency markets appear lethargic too. The low liquidity environment of the end of the year has seen most currencies stay within a very tight and unthreatening channel. Today, the biggest major mover of the day was the US Dollar. Today’s market movements seem rather reminiscent of the entire year: a mixed pound sterling, struggling for definitive direction and largely unchanged. The Euro: advancing strongly with intraday gains just shy of +0.5% and year to date advancements scraping close to +10%. The Dollar: yet another bearish episode; down by up to 0.5% on the day and with losses in excess of 11.5% (against the Euro) throughout 2017. Below I question what will 2018 hold for FX markets.

 

 

Sterling Briefing: Another year of Brexit?

 

2016 was the year of Brexit… Without a shadow of doubt. But what with Lancaster House, Florence, and sufficient progress to name but a few of 2017’s Brexit events, perhaps this year too has been the year of Brexit. With Britain’s official secession from the European Union not until March 2019, next year could be a politically driven roller-coaster too.

 

One theme that has pervaded through Brexit ups and downs has been a consistently bullish Pound Sterling from the shock lows of late-August. It is highly possible that 2018 sees the British currency trade within a channel capped by parity at the lower end and 1.20 at the upper end. However, a more optimistic analysis would note the consistent support for the Pound outside of devastating Brexit events.

 

A simple projected regression of the illusive positive trend would suggest that by the end of 2018, the Pound would be trading close to 1.18 against the Euro and just shy of 1.50 against the US Dollar. Moreover, these projections are not dissimilar to the projections of many major market participants.

 

 

Euro Briefing: Blink and You’ll Miss It

 

The region of Catalonia has a dichotomous framing across the globe: a virtuous and democratic freedom of expression versus an illegal, destructive movement. Whatever the more accurate view, markets should be focusing on one thing: a rise in systemic political risk and uncertainty within the devolved regions, Spain and the Eurozone is inevitable. Therefore, what remains puzzling is the insensitivity of currency markets, and the trading value of the Euro, with meaningful developments of the Catalonian political challenge. This likely uncovers the newfound bull-bias of investors with respect to the Euro. However, the tension might be visible beneath the surface, escaping only on Christmas Day.

 

In the late afternoon on the 25th November, according to Bloomberg data, the Euro slid by around three percent against the US dollar in all but a matter of minutes. The rapid devaluation, or ‘flash crash’ saw the Euro fall to a value of less than 1.17 Dollars. The move has been attributed to algorithmic trading in a low-liquidity market. Only a few hours later, the pre-disturbance value that threatened 1.19 returned.

 

What will become increasingly important is what activated the algorithmic trading devaluation. Besides reactive pricing action, it is plausible, if not likely, that mistaken pessimistic Catalonian news and Eurozone uncertainty caused the sell off of the Euro. If this conjecture becomes verified, there is significant potential for 2017’s bullish Euro, the best performing G-10 currency, is winding down. Whilst there remain few Dollar bulls in the market, a change of market dynamic could be possible, especially when considered alongside forthcoming Italian elections and an as yet incomplete German coalition deal.

 

 

Dollar Briefing: Fake News

 

The US Dollar has lost considerable ground this morning, rounding off its abysmal year-to-date performance. A Dollar short has been one of the best investments of 2017 alongside the likes of the crypto-currency explosion and Portuguese public debt.  While many investors lost out, the 2017 bullish Dollar was nothing but Fake News.

 

 

The Days Ahead:

 

As we hope you continue to enjoy the festive season, we will bring you a year end round up as we approach 2018. With the largest upside potential arguably within the Pound next year, we await to see whether British optimism has the better of us!

 

 

Discussion and Analysis by Charles Porter

 

 

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Why is everyone so happy?!

Discussion and Analysis by Charles Porter:

 

Deputy Governor of the Bank of England, Dr. Ben Broadbent, gave a speech two weeks ago on Brexit and interest rates. The take away message from the speech was that a disharmony between a happy public and negative markets is driving inflation. The Deputy Governor suggested that there is a “pessimistic view of Brexit in financial markets”. In contrast, households are “sanguine” about Brexit; happy that it’s going well and optimistic about a good exit. 

 

The beliefs, or at least publicised sentiment, of politicians is frequently in accordance with markets. David Davis has frequently been quoted to attribute the odds of a ‘no deal’ and WTO reversion at around 50%. The wider Bank of England and its Governor, Mark Carney, have shown comparable cynicism about Brexit.

 

So the question remains, why is the public so happy (or why are markets and politicians so downbeat)? Let’s go with the former: I don’t really know. However, one thing is for sure; it’s not limited to the United Kingdom and Brexit.

 

Look at Germany. The general election passed over two months ago with a weak but unequivocal win for Merkel’s Cristian Democratic Union. Since then, negotiations to establish the so-called ‘Jamaica’ coalition collapsed with impassable FDP resistance.

 

The instability of these talks should have been understood in conjunction with the (now unfounded) reluctance of the SPD to entertain talks with Ms Merkel’s Union. Similarly, although the Germans are rather inclined to low inflation, its concomitant unimpressive economic growth should inspire concern in the domestic economy.

 

Inflation, as measured the consumer price index, was read once again last week. It did show a moderate up-tick in annualised inflation to 1.8%. Therefore, the rate of inflation within the single currency’s largest economy is improving, however, still below target.

 

One would therefore anticipate that public sentiment within Germany would be mild-to-weak; certainly not resoundingly positive. That’s simply not the case. The German population, just as the UK public, plainly seems to be far too happy.

 

The ifo Institute’s Business Climate Index, is incredibly inflated. The report suggests that, in Germany, we are well inside economic boom territory; at the highest level since before the 2008 financial crisis. This sentiment seems unjustified. Across the struggling Eurozone as a whole, a comparable IHS Markit report shows composite sentiment at a 79-month high.

 

 

What is both amazing and concerning is that the current level of sentiment, or ‘happiness’, in Germany would be indicative of a rate of economic growth close to 6%; a reality unlikely to set in any time soon, if ever. Of course, this calculation and regression is based upon spurious assumptions including a linearity between sentiment and output. However, the model does fit well and a set of expectations that are likely to be undermined is dangerous both for the domestic economy and the single currency.

 

Having recently tested 1.20 against the US Dollar once again, the Euro could be overvalued. With monetary policy in the Euro area likely to stagnate for the foreseeable future, at least until the asset purchase program expires, markets have been rather sensitive to data, including soft data.

 

The single currency is never going to enter into a bubble in a characteristic sense. However, there is a danger it will become gradually overvalued, creating downside potential within the Euro.

 

 

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Daily Newsletter

Discussion and Analysis by Charles Porter:

 

After a busy day on currency markets yesterday, the biggest mover ahead of today was the Euro, followed closely by the Pound. Heightened volatility was unsurprising given the central bank monetary policy decisions that occurred in the underlying economies of the respective currencies. Monetary policy decisions from the Bank of England and the European Central Bank yesterday left both monetary policy instruments and expectations on hold. The ECB confirmed that it will restrain asset purchases in the new year at €30bn, down from 2017’s €60bn average and crisis highs of €80bn. Following a recent hike, the Bank of England Rate is held at 0.5%. The EU summit concludes today, allowing market movement.

 

Sterling Briefing: Existential Pound

 

Politics or Economics? The Pound’s internal conflict is leading to interesting dynamics on forex markets. The United Kingdom’s polity and economy have both thrown up surprises, frequently in opposing directions, that are causing a cautious pound with considerable average intraday volatility.

 

Yesterday afternoon saw the UK parliament strike a blow to Theresa May by voting through an amendment to the government’s cornerstone Brexit legislation, and allowing the UK parliament a full vote on any Brexit deal before government implementation. This political result creates two devastating effects to May’s leadership. Firstly, the defection of party members voting against strong government whips publicly conveys an air of weakness to the incumbent government. Secondly, in more constitutional terms, the amendment turns Brexit into a more salient partisan affair, by equating the composition of the Commons with the ratification of a Brexit deal.

 

Sterling’s interesting internal dynamics are raised by the expectation of imminent EU Council approval for second round progress. The conflict questions what is more important; internal or external politics? Similarly, slow economic progress with the Bank of England decision leaving policy expectations unchanged extends Sterling’s existential crisis further: how should all this news be priced into the Pound?

 

 

 

Euro Briefing: Stolen Summit

 

The progression of the European Union, and not least the Euro, is often referred to as the European experiment; and rightly so. The stab in the dark, beginning less than a decade after the conclusion of the second world war, was revolutionary. Now, however, the experiment is changing and, in my opinion, spilling over into markets.

 

Any single currency that is achieved by the amalgamation of many domestic currencies will always bring new challenges. However, even more so than with the Pound, discussed above, a central challenge is isolating the arena of salience to a collective currency.

 

Westminsterial politics is the traditional ground for UK political developments; a certainty that cannot be ascribed to the Euro area. In what should be a focal point for the Union’s and Eurozone’s politics, today’s Summit is still dominated by national idiosyncrasies, not least Brexit. Yesterday, a steady outlook for European monetary policy summarized the same message: growth is good, however, the average price level (inflation) remains highly illusive. Without wage growth, the value of the Euro may be subdued. Yesterday’s decision saw the Euro fall 0.7% to 1.178 against the Dollar and 0.8765 vs. Sterling.

 

 

 

Dollar Briefing: Back to Tax

 

Yesterday evening, equity markets in the US closed in the red lower, reflecting concerns about the viability of Trump’s tax reform bill. This morning, the Dollar has opened mildly lower on European markets, continuing last night’s trend. Trump’s optimism for reform before Christmas may well be taken at face value by markets, creating a risk that the year-end balancing that typically favours the Dollar, and has done so far throughout December, might be undermined and even reversed.

 

 

 

Across the Globe:

 

Yesterday evening Governor of the Bank of Canada, Stephen Poloz, gave the first hint that Canada will require “less monetary stimulus over time”. This comment strengthened the Canadian Dollar by over 1%, making its purchase more expensive.

 

 

 

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EU Summit

Discussion and Analysis by Charles Porter:

 

Yesterday afternoon, the US Dollar only continued its unrelenting advance. Since the beginning of De­cember, the Dollar has gained almost 1.5% against its shared currency counterpart, the Euro. The EUR USD cross now threatens 1.17. The most notable event of today will be an interest rate decision by the Fed’s Open Market Committee. As the Fed continues to sit today, following the commencement of the meeting yesterday, Dollar markets can still be moved on speculation ahead of the event. Ultimately, the Fed’s decision looks like a foregone conclusion; a 25 basis point hike in interest rates. However, ahead of this decision, all-important CPI inflation data, the facilitator of central bank action, will be released.

 

 

Sterling Briefing: One More Sleep…

 

… Until the judgement period begins! As we all count down the days up to the culmination of the festive season, for markets at least, there are several hurdles in the way. Thursday and Friday mark the deadline for first round Brexit progress in 2017. The probability of Brexit defeat at the end of this week remains minimal; self preservation and the reputation of Commission President, Jean-Claude Juncker, and European Council President, Donald Tusk, would suggest that the declaration of progress is in the bag.

 

The European Council meeting for December will start tomorrow. Headlines should not take long to start flowing as rumours already abound about the likely concretization of the supposed progress on Brexit. With the political scene in Germany clearing, yet still highly uncertain, there will be other concerns at the Council summit. Similarly, the recent instability within Ireland and the resignation of Deputy PM, Frances Fitzgerald, could dilute an otherwise Brexit-centric affair.

 

Ahead of the European event, markets will receive data on the UK labour market, a key variable to the value of Sterling when considering the Bank of England’s fixation upon low wage inflation amidst strong price inflation. This event may prove to move the Pound further than normal due to the temporal proximity of the data release to tomorrow’s Bank of England monetary policy decision.

 

 

 

Euro Briefing: The Bigger Picture

 

Hard data matters; economics matters; monetary policy matters; politics matters. These are facts and most of the time are rightly treated as indisputable axioms of the modern world. However, markets and individuals appear to be split on how much ‘soft’ data and sentiment matters.

 

Academia has advanced the efforts of, to name but one example, behavioural economics, and the marriage of psychology and sociology to Economics. Sentiment truly matters over the long run. Despite the current losses for the Euro against the Dollar and, for that matter, the Pound since Mid-November, the Euro is up by over 7%, on average against the world’s major currencies in 2017.

 

In terms of sentiment, ask yourself: can we truly consider the European Sovereign Debt Crisis that destroyed the value of the Euro since 2010 to be over? I, and many others tacitly would argue; yes. The normative sentiment of an un-marred Euro has made it a good long purchase throughout this year.

 

 

 

Dollar Briefing: Plain Sailing

 

Janet Yellen, the present Chair of the Federal Reserve in the US, will leave office in 2018. President Trump has nominated ‘Jay’ Powell to become the new leader of the Fed in a move that is unlikely to change the status-quo outside of financial regulation, but nicely puts an egoistic President’s stamp on the monetary policy authority.

 

Due to the change of leadership, Janet Yellen’s words at the Press Conference following tonight’s monetary policy decision are unlikely to move markets; she is no longer salient in the attempt to predict future monetary policy. As such it is likely to be plain-er sailing than normal during tonight’s decision. A 25bps hike is 98% priced into the currency making the USD upside potential minimal.

 

 

 

The Day Ahead:

 

The ECB, the Fed, and the Bank of England will all produce their monetary policy decisions within 18 hours of each other. With the Fed kicking off proceedings this evening, today remains the last full day to price in expectations within the Pound and the Euro.

 

 

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