Where do we go for 2019? What can we expect in the financial markets?
2018 saw the resurgence of volatility in the currency markets, which many investors spoke of fear and uncertainty and economists were somewhat scratching their heads. Even the bigger players predictions were a huge miss.
The dollar was the main catalyst for changes in market sentiment. Exchange rates held stability until March/June, at which point the US yields were going to rise sending the US dollar higher.
Emerging currencies at this time started to show some dramatic movements as well. The Chinese yuan weakened substantially along with the Turkish lira, and some retail brokers placed a ban on trading these currencies at the peak of the movements and market volatility.
Looking ahead, as investors and traders we must analyse several key points and factors in navigating 2019. The ECB will play a key role in 2019 on policy, and it is worth remembering that Mario Draghi's tenure at the ECB is coming to an end. This will weigh in and the market may pre-price itself for instability during the change. The Fed itself will naturally play a role as well; will it tighten the two times the dot plot suggests or is the market right in essentially pricing out rate hikes by the FOMC in 2019?
2019 also has the political events of both the UK and US to throw more turmoil into the mix. The question of Brexit and will it be hard or soft? Will there be a Trump impeachment? Could there be an end to the trade war? And what of Italian and German banks and debt?
So it does not matter which you look at it, the volatility is set to remain and for traders who are wary, systematic, strategic and patient the year could bring some healthy gains.
United States Dollar
The US dollar regained dominance in the currency market during 2018. It was February 2018 that Jerome Powell replaced Janet Yellen and became the 16th Chair of the Federal Reserve.
It became apparent almost instantaneously that the Fed would raise rates, and continue to do so multiple times in 2018 and 2019, which in turn led to a rise in US yields, guiding the yield differential between major counterparts in favour of the US dollar.
It was also at this time that the Australian dollar completely fell out of bed against its U.S counterpart, after an almost interstellar gain late 2017. I was fortunate enough to personally carry a short trade on the Aussie for most of the 2018 year. All with the expert market analysis of one extremely talented Gregory McKenna, who called on the 2nd of Feb, short on the AUD [1].
Jerome Powell remained hawkish for 2018, and it was late 2018 that the Fed forecast confirmed the central banks’ intention to increase interest rates 3 more times in 2019, in addition a rate hike was scheduled for December. It was late 2018 that Powell said monetary policy was still ‘accommodative’, and there was further to go before the Fed funds rate hit neutral.
Jerome Powell retreated on that as the December meeting approached and the week before Christmas the hawkish tone of the Fed was lessened as the Fed increased the fund rates by 25-basis points, but also signaled a potential pause in 2019. The Fed did this by forecasting an increase in interest rates by 50-basis points in 2019 instead of the 75-basis point previously forecast.
The most liquid and traded currency pair, US dollar and the euro has a peak to trough move of nearly 10%. The increase in the value of the US dollar may be curtailed by a slightly less hawkish Fed. The markets are signalling that rates have reached restrictive levels which might reduce US dollar volatility moving forward as traders weigh the relative merits of the U.S against other Nation States and Jurisdictions.
A conceptual issue that the Fed and by proxy, traders, are grappling with is, exactly where is the neutral point in interest rates? That is the rate that is neither restricting nor stimulating growth in the US economy.
Jerome Powell said himself that he is not sure. It is what is driving the “data dependency”, as referred to by Powell and his colleagues. That is just central bank rhetoric for they are not sure, which has impacted the foreign exchange markets and traders, who are confused on the outlook for the Fed funds and other US rates so many asset prices and the US dollar depend on.
The period of quantitative easing is at an end, and the Fed is winding down its balance sheet, which it expanded during the Financial Crisis. This strategy to reduce its holding of bonds, known as QT or Quantitative Tightening, predates President Trump but the President has been critical of the Fed (see below) increasing rates during 2018 as well as the QT program.
It is a measure of the lack of attractive alternatives that the presidents aggressive intervention has seen the U.S dollar and other assets under great pressure as they would have been if this occurred in nearly any other country. Yields would soar as investors extract a steep price for criticism of the Central Bank.
Pound Sterling and Brexit
The pound, along with the Aussie, was a big loser in 2018. Brexit weighed heavily on the pound and each tumultuous news release triggered vigorous selling. What is interesting is that the UK economy has held up much better than almost any forecaster expected. That failed to help Sterling though which even with some positive print economic data, saw the sentiment remain to sell the rallies. The decline in the pound coincided with strength in the US dollar. The GBP/USD had high to low range of 13%.
Chinese Yuan
The Chinese yuan also was one of the biggest movers during 2018. The currency began to weaken as trade issues between the US and China began to heat up, President Trump appeared to for much of the year to have an unwavering stance on China, implementing tariffs and restrictions on the people’s state.
As of the year-end though, the rhetoric between President Trump and President Xi has softened even as U.S negotiators continue to hold a hard line. Having let the USD/CNY rate weaken towards 7 as the People’s Bank of China sought to offset softening exports with a weaker currency, authorities have kept the yuan fly stable in recent months. This remains the case even though the final quarter of 2018 saw Chinese economic data began to soften materially. The question is whether this weakness was already foreshadowed by the weakening currency or there are further falls for the Yuan to come. As of year-end Chinese PMI data moved into contraction territory which points to further contraction in the Chinese economy. The high to low range was nearly 11.5%.
2019 and where I am looking?
I personally remain a US dollar bull given its economy offers a more positive backdrop, coupled with the greater economic, political and fiscal issues facing the world outside of the United States. Any negativity from internal U.S political distaste, will be negated: by the Fed continuing its policy, a positive print in U.S economic data; greater negativity and drags in other markets and economies more broadly.
Even though I have this stance, it is prudent to remember that as traders we can only trade the price as we see it, and to keep in mind that markets and sentiment can change at a whim. So while 2018 was the year of the dollar, there are many issues that can change the narrative in 2019. The Fed may reduce the number of rate hikes to 1, instead of 2. U.S traders have yields at levels which already reflect this. That may in turn reduce the value of the dollar.
President Trump has the likelihood of being impeached, though it is highly unlikely, the Senate will convict him, and purely for the reason of the precedent it will set. If this becomes the case, the markets could become very volatile and the U.S dollar will almost certainly suffer a setback.
U.S yields, would decline instead of rising, lending more probable weakness to the U.S Dollar, at the same time, investors would be looking for a safe-haven currency which would likely be the yen and the Swiss franc.
Even if none of the above does occur, a potential recession in the US would weigh on the greenback.
Borrowing a phrase from the great Ed Seykota, Greg McKenna at mckennamacro.com often says the old adage of “the trend is your friend, until it bends or ends” which in this traders humble opinion translates to, “trade the price as you see it”.
Again, in his teachings he re-iterates often, “do not guess the end of a particular price bar”, “do not ‘Think’ that you know where a market is going” and “never rush into any trade, there is always another day”.
So I keep my mentors words in mind, I follow the trading plan and reduce my risk by remaining strategic and patient.
[1] Twitter @gregorymckenna – LinkdIn Greg Mckenna – Web mckennamacro.com