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SVB Confidential
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SVB Confidential
The dollar spent the first half of the year trending upwards, benefitting from a relatively strong economy and leveraging its status as a safe haven asset.
Following a brief hiccup in June, the dollar index peaked in October before paring gains to close the year near its opening levels as the effect of three interest rate cuts in four months were realised.
When forecasting for the year ahead, the appeal of the green back faces key headwinds in the form of trade tensions, the presidential impeachment enquiry and a central bank struggling to convince the market the economy is mid-cycle.
What happened?
“A shift to risk-off sentiment, coupled with clearer guidance from the Fed, supported capital inflows that buoyed the US economy in the face of rising domestic and international political tensions.”
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President Trump became the third US leader to face an impeachmentenquiry as House Speaker Nancy Pelosi announced allegations that hepressured his Ukrainian counterpart into investigating former VicePresident Joe Biden and his son. The President responded by declaringthe process a witch hunt, motivated by political mud-slinging in thebuild up to the US Presidential election in 2020.
Market reaction to developments has been muted to date asparticipants chose to lay their focus elsewhere.
The House of Representatives have backed the impeachment casehowever it is unlikely the president will be removed from office while theRepublicans hold the majority in the Senate.
Despite the impeachment issue being a key theme in the run-up to theNovember 3rd presidential election. Statistics are likely to dominate therhetoric. With unemployment hovering around its lowest level since1969 and a stock market regularly setting fresh record highs, historywould be quick to remind the market that only five sitting presidentshave failed to be re-elected and no President has ever been removedfrom office when the economy is doing well.
Investors are traditionally adverse to uncertainty and a close electionrace will do little to deter appetite to hold significant dollar balances untilthey know who will serve the next term and how accommodative theirpolicies will be.
The Federal Reserve lowered interest rates three times in 2019 as theylooked to support the economy and guard against a possible slow down.Fed Chair, Jerome Powell, described the easing process this year as “mid-cycle insurance”, which concluded after the latest interest rate cut,providing a ray of hope for those hoping for further economic expansion.President Trump continued to bring the independence of the central bankinto the spotlight, regularly calling for lower rates and looser monetarypolicy to help stimulate the economy further.
Market positioning appears less convinced that the Fed’s policy easing isa mid-cycle pause, with participants leaning towards an additionalinterest rate cut from the central bank this year, characteristic of a full-easing cycle.
Anything the Fed provides that might hint at tighter policy could helpbolster the attraction of the dollar, as it signals divergence from its globalpeers. However, a fall in yield often comes hand in hand with a loss ofappeal.
US – China trade negotiations continued to rattle markets throughout2019, with sentiment changing on a near-daily basis.
The tentative phase one of agreement of a trade deal involving Chinesegoods and US agricultural products spurred a relief rally but the marketremained cautious as the deal is yet to be signed.
A World Trade Organisation (WTO) ruling saw the US & EU startrumblings of a trade war as the US announced they would imposetariffs on EU manufactured Airbus planes and on French wines inretaliation for illegal EU aircraft subsidies.
Closer to home, the US-Mexico-Canada trade pact is currently awaitingratification in the Senate, which would hand Trump a legislative victory.
Trade has been a key priority during Trump’s first term in office and heshows little sign of relenting on his pursuit to secure ‘fairer’ terms fromkey trading partners. As phase two of the US–China negotiations begin,it’s likely Trump’s ‘America First’ standpoint will continue to driveturbulent talks.
Concerns around protectionism have shackled stock market rallies, withclear momentum accompanying each announcement of progress onreaching an agreement . A concrete outcome that indicates a long-termresolution could be the boost that pushes equity indices to new recordlevels and renews the popularity of the greenback.
SVB Confidential
“Brexit emotions ran high and GBP whipsawed as the market repeatedly repositioned with each dramatic turn of events.”
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The Bank of England played a supporting role throughout 2019 as MarkCarney and his committee caveated any commentary with reference todependencies on the future path of Brexit.
Economic data remained mediocre as business concerns began to manifest inthe statistics. The second half of the year saw inflation wane, wage growth falland manufacturing and services Purchasing Manager’s Index (PMI) remain incontraction territory. The breathing space the Bank of England enjoyed at thestart of the year slowly faded and the pressure began to mount on thecommittee to safeguard the domestic economy from a further slowdown.
The BoE appears unable to take a stance until we have further clarity on Brexitoutcomes and even the most experienced forecasters have been left secondguessing the expected path of monetary policy.
The spotlight will gradually return to the Bank of England as its ‘wait-and see’approach reaches its expiry date. Market participants will need more than stockBrexit related responses for direction regarding policy. Mark Carney’s tenure asgovernor is due to end in June 2021, with Andrew Bailey (the current head ofthe FCA) chosen as his successor.
The market currently favors a more dovish stance after two dissenters of thenine person Monetary Policy Committee (MPC) voted for an interest rate cut atthe last meeting. However the odds of an adjustment before the end of theyear peak at 44%, evidence that the market is sitting on the fence until the MPCprovides clearer guidance.
Should the central bank succumb to economic pressure and cut rates in aneffort to stimulate growth, the relative attractiveness of sterling will likelydiminish, increasing down-side risk to the pound and compounding Brexitrelated concerns for the currency.
Political headlines continued to send shockwaves through FX markets asparticipants were obliged to keep one eye on news headlines throughout theyear. The pace of announcements showed no sings of easing with TheresaMay surviving a vote of no confidence before later stepping down in responseto mounting pressure from her own party.
The resignation left the door open to a leadership contest that saw BorisJohnson fend off a number of his close rivals to take the helm as ConservativeParty leader and inherit the role as prime minister.
The appointment of Johnson brought a fresh face to a fatigued Brexitnegotiating table. His convincing victory in the election has reduced the levelof political uncertainty that had been restraining sterling as the marketbecame more optimistic that the stalemate with the EU could be overcome.
The prime minister now has a commanding majority of 80 MPs, affording himthe parliamentary backing to pass his withdrawal agreement. With the cliff edgeexit date set for 31 December 2020 and Johnson refusing to seek any furtherextension, there remains a number of long nights ahead for those involved inthe negotiations.
Although the market has generally welcomed political certainty, which on thesurface has driven GBPUSD to recent highs, there remains a significant numberof known unknowns in the path to leave the EU which could have negativeimplications for the pound.
Should the political musical chairs that we have witnessed in recent years cometo an end and a smooth Brexit departure path be agreed, we could witness afirm recovery in the pound, however if the two sides of the table remain atloggerheads and the UK crash out with a reversion to WTO rules, the poundcould once again loose its footing.
SVB Confidential
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The ECB consistently lagged behind its target inflation rate of ‘at or below 2%’as global economic and political headwinds translated into a manufacturingslump and dampened investment growth within the eurozone.
The ECB kept rates on hold throughout 2019, largely in line with expectations,as the euro slowly faded lower throughout the year. Before handing the reinsover to Christine Lagarde, former ECB president Mario Draghi used his finalpolicy setting meeting to reinstate quantitative easing measures, cut depositrates and introduce a tiering system in an effort to encourage lending whilstreducing the burden of excess reserves.
As the market looks to evaluate the effectiveness of the latest policypackage, the expectation is for the ECB to leave policy unchangedthrough 2020 as Lagarde has pledged to remain neutral, labelling herselfa “wise owl” as opposed to a hawk or dove.
Lagarde’s immediate focus will likely be on building cohesion in theGoverning Council, promoting more active fiscal policy to boost theeurozone economy and kicking off a wholesale review of ECB strategy.
The first formal review since 2003 is expected to assess and clarify theECB’s mandate around price stability and build an understanding ofwhether the economic lethargy is a function of short-term cyclical orlong-term structural factors given the trillions that have been pumped into support the system.
The threat of trade tariffs, protectionism and Brexit could further weighon the Euro if uncertainty persists and member countries with budgetsurpluses can’t be persuaded to prop up the economy by bringinginvestment back to or above pre-credit crisis levels.
Germany: The second half of the year saw a slight improvement in underlyingeconomic conditions as jobless rates stayed stable and investor sentimentand business confidence closed the year with a positive slant. Germanymanaged to stave off the dual risks of technical recession and increasingpolitical polarisation amidst calls for Berlin to start spending their fiscalsurplus and avoid the threat of economic stagnation.
France: 2019 saw instability for the bloc’s second largest economy aspresident Macron continued to encounter roadblocks to his reformist agendain the from of the ‘yellow vests’ movement, hampering attempts tomodernise the state. The movement, paired with a budget deficit thatcontinued to exceed the eurozone maximum of 3% of GDP, sent signals ofcaution to the market.
Germany: Political gridlock and diverging views between the coalitionparties could force a snap election before Merkel steps down in 2021 asthe Christian Democratic Union (CDU) continues to stick by its balanced-budget policy. Lack of domestic fiscal stimulus in the face of exportuncertainty fueled by global trade tensions could signal trauma in aneconomy already seeing the effects of a car industry pivoting to non-traditional electric vehicles, growing stock piles and thinning orderbooks.
France: The public will head to the polls in March for local electionswhich will act as a proxy for the amount of support Macron currently hasas his La République En March party remain at loggerheads with the far-right Rassemblement National. The outcome will give an insight into theviability of Macron’s long term reform agenda and his general popularityin office.
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