Seeing as its our last market update of 2016, let’s take a look at what happened this year and what could happen next year in foreign exchange markets.
The Pound was one of the big movers in 2016. On a trade-weighted basis Sterling declined -17%, making it the worst performing major currency. Most of these losses came as a result of Brexit: first as investors sold the Pound ahead of the EU referendum, and after as traders reacted to the vote and the uncertainty that it has caused.
Sterling hit a low point on October 7 when a flash crash took GBP crosses to multi-year lows, however, since then the Pound’s fortunes have improved. Rising inflation has prompted the Bank of England to move away from its easing cycle, solid economic data has confounded doomsaying forecasters, hopes of retaining single market access have grown and Donald Trump’s election victory has shifted the spotlight away from Britain.
In 2017 a lot will depend on whether the government opts to pursue a post-Brexit future inside or outside of the EU single market. Much of the uncertainty for British businesses could be eradicated if Prime Minister Theresa May outlines plans to remain in the single market when she officially begins the two-year EU divorce procedure in March. If Downing Street opts to flout single market access in order to rein-in immigration then it could be a very different story for the Pound as investors would likely see that as a risk worthy of selling Sterling assets in response to.
The Pound to Euro exchange rate has fallen by around 20 cents since the beginning of the year, mostly due to Brexit. However, GBP/EUR has recovered by around seven cents from the seven-year low it struck in October and there is potential for further Sterling rallies in 2017.
Providing UK growth holds up and the government opts to retain single market access – these are certainly not givens! – then we could see the single currency soften over the year around the time of three key general elections: Holland (March), France (April) and Germany (September). Following the surprise victories for the Brexit camp and Donald Trump, traders have become worried that a wave of populist nationalism could unsettle established political parties and throw Europe into a state of panic. If anti-EU parties gain support, or even challenge for leadership, in any of these elections, then the Euro could start weakening. Even before the EU referendum we argued that Brexit had more severe long-term consequences for the Euro than the Pound, because if anti-EU parties continue to rise the single currency’s very existence could be at threat.
Having declined 25 cents and hit a 31-year low, it’s safe to say that 2016 was a bad year for GBP/USD.
Brexit sent Sterling reeling and the Federal Reserve’s decision to hike rates in December prompted another spell of weakness for ‘Cable’.
In 2017 the US Dollar looks set to post rallies across the board as President-elect Donald Trump embarks on extravagant spending sprees, which should create jobs, boost wages and drive inflation higher, therefore prompting the Fed to continue with its hiking cycle. Three Fed rate hikes are projected next year and if they come to pass then it is entirely likely that the Pound to US Dollar exchange rate will depreciate again.
However, the Fed predicted four hikes in 2016 and only managed one, so there is still a chance that the ‘Greenback’ may not run away from the pack. As we speak, GBP/USD is trading a couple of cents lower than what most analysts deem fair value for the currency pair.
Sterling fell by over 40 cents versus the Canadian Dollar this year and rising oil prices could take the ‘Loonie’ higher still in 2017.
Recent oil production cuts from OPEC and non-OPEC nations are due to kick-in on January 1. The reduction in supply is likely to drive prices higher, which should give the Canadian Dollar a boost because crude is the nation’s most lucrative export. However, there is a possibility that the historic production cuts will prove self-defeating because US shale producers could conceivably see the oil price rises as a trigger to re-enter the market. This would send supply higher again, therefore pressuring prices and potentially wiping out demand for the Canadian Dollar.
The Pound to Australian Dollar exchange rate tanked 32 cents in 2016 as Brexit jitters weighed heavily. However, Sterling has recovered 10 cents since November and Trump’s protectionist policies could allow GBP/AUD to surge in 2017.
If the President of the world’s largest economy chooses to launch a programme of measures detrimental to world trade then it could prompt similar policies from other nations. This would have a significant negative impact on the ‘Aussie’ because the Australian Dollar trades with volumes far higher than the size of the Australian economy warrants. High yields attract investors but if things start to go wrong, AUD can experience rapid declines. In addition to the threat of protectionism in the US, the Federal Reserve’s intentions to raise rates three times in 2017 could also damage the ‘Aussie’ by cutting the yield differential with the US Dollar, therefore driving investors into the safe haven of the ‘Greenback – the world’s premier reserve currency.
GBP/NZD lost out on 40 cents in 2016 as Brexit anxieties gutted demand for the Pound.
In 2017 the New Zealand Dollar faces similar risks to the Australian Dollar, in that both Antipodean currencies benefit from higher interest rates than most majors but suffer from significant volatility due to the relatively small sizes of their domestic economies. This means that The Pound to ‘Kiwi’ Dollar exchange rate could recover in 2017 if risk sentiment is damaged by protectionism in the US and hawkish Fed policy.
Happy New Year from everybody at TorFx
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