Since 2016, with watershed moments like the Brexit referendum and U.S. presidential election, geopolitics have grown more consequential to the foreign exchange (FX) markets. At present, global policy uncertainty remains elevated, with potential impacts for the U.S. Dollar and various foreign currencies.
These highlights, from our February 2019 webinar “Navigating FX markets as Brexit concerns mount,” can help finance professionals and risk managers stay informed and set an appropriate course.
U.S. Dollar outlook. After several interest rate hikes in 2018 and a fairly “hawkish” policy stance, the Federal Reserve recently shifted to a more cautious, “dovish” approach. To us, this signals the end of the Fed’s multi-year tightening cycle and a possible rate pause; Wells Fargo anticipates just one interest rate increase in 2019.
U.S. economic growth. In 2017 and 2018, the U.S. economy outperformed its counterparts in Europe, Canada, and Japan. As 2019 advances, we anticipate U.S. growth to slow somewhat, from around 3 percent at present to closer to 2 percent by 2020. However, the fundamentals remain solid; there’s no recession in sight.
At the same time, we expect global growth to improve, causing the pace of U.S. and global economies to converge. Based on these projections, Wells Fargo anticipates the U.S. Dollar to weaken later this year and in 2020, and that’s reflected in our foreign exchange (FX) forecast.
Global central banks. In general, other central banks have become more cautious in their policies. In order for foreign currencies to strengthen, these central banks must first become more active. We expect that to happen later in 2019 and into 2020. We anticipate most of Europe’s central banks will raise rates by the end of this year.
Across the Eurozone, economic weakness has become more concerning. As we look beyond the headlines, we see this slowdown driven more by internal than external factors (like Brexit or China). European monetary policy is still extremely accommodating, and consumer spending remains strong, so our view is that it’s a soft patch and the Eurozone can get through it.
Brexit risk factors. The nature of post-Brexit relations between the European Union and the U.K. remains highly uncertain. Discussions on future trade relations have barely begun, and will likely take several years, as the average trade agreement requires about four years to establish. We expect to be talking about Brexit into the early to mid-2020s, with the pound and the U.K. economy generally subdued during that time.
China trade relations. Looking at retail sales and industrial output, we see a fairly broad slowdown on both sides of the Chinese economy. Fortunately, as growth has slowed, Chinese authorities have taken action and eased their monetary policy. However, even though they’ve cut taxes, increased infrastructure spending, and reduced interest rates to stimulate borrowing, the Chinese renminbi is strengthening. Some of this we attribute to optimism on U.S.-China trade talks, as well as a softening U.S. Dollar.
Slowing in Canada. Canadian economic growth has slowed markedly, and there are concerns about recession. However, Wells Fargo is less bearish in our Canadian dollar outlook, because we believe Canada’s economy is growing at its potential right now, and that fundamentally, things look good.
Two primary factors are driving concerns. First, while Canadian oil prices have recovered, they remain generally low. Second, risks are rising in housing markets, with stagnating prices in several key metropolitan areas. As a result, we expect the Bank of Canada to continue tightening, but at a slower pace than previously, with two rate hikes predicted in 2019.
Moderation in Japan. In Japan, both economic growth and inflation remain moderate. In that climate, the Bank of Japan’s core message of easy policy is unlikely to change anytime soon. Still, we see room for the yen to gain modestly over time as the dollar weakens and as global political concerns lead to safe-haven buying of the Japanese currency.
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