One axiom about the foreign exchange market is that it is extremely difficult to predict forex rates for any pairings for a week, a month, and even for a year. It does not matter if you are a novice or an expert, forecasts can change on a dime due to a series of various influences, whether they be event driven, data dependent, or subject to some “unknown unknown”. Despite the difficulty, however, forex analysts, as part of their chosen career path, are required to make best efforts at predicting the future for foreign exchange.
The process begins with a plausible narrative for how the next year is expected to unfold, taking into account anticipated economic, financial, and political trends. This universe of data obviously has many moving parts and assumptions that must be made, the reason for the high degree of error in the first place. These analysts have also learned to cover their tracks by constantly revising their predictions, due to whatever changes transpire in the global marketplace. Nevertheless, you will never see any mention of how far they missed the boat in a given period. Accountability is absent.
How well did the analyst community fare for its guesses for 2018? Let’s compare a general average against actual results and find out – See below:
In this crude version of a sensitivity analysis, our forex experts, on average, were off the mark by 5.4%, at least with these major pairings with the U.S. Dollar. The consensus narrative for the year presumed that the Almighty Dollar would become, well, less almighty. It did not, except with respect to the Yen, which had a stronger pull in the “safe haven” arena with investors. There may have been a few “outliers” that might have seen the main event of the year coming, but most everyone missed the crisis in emerging market countries. Turkey and Argentina scared investors to the core. As the yield curve flattened, concern increased further, all leading to a rush for safety, i.e., safe havens.
If you look down through the variance column on the right side of the diagram, the figure for each pairing summarizes the prevailing issues pertaining to each relationship. The EU continued to miss its growth and inflation targets, floundering about while populism and various national economies declined. The Pound also suffered through protracted Brexit negotiations, which have not reached an acceptable conclusion. The emerging market crisis strengthened the Yen, and USD, as well, but not near as much.
The Aussie contracted, too, as Chinese officials tried their level best to stimulate their economy. A GDP growth rate of 6.5% was achieved, but raw resources had already been stockpiled. Australia and other resource rich countries would have to wait. Canada also fell victim to lack of demand for commodities, in this case oil. Crude had ascended to the $80 per barrel height, but in the last few months of the year, the bottom fell out of the market. By the end of the year, oil had dipped below $50 a barrel.
After being burned to the tune of 5.4% for 2018, banking analysts were a bit slower in releasing their predictions for the current year. Stocks were in turmoil. Trade negotiations between the U.S. and China seemed destined for nothing good, although a ninety-day truce became common ground. The end of March would now be cluttered with trade and Brexit issues, with no crystal ball to shed light on the potential outcome of either problem area.
But a narrative must be reached or at least conjectured, because foreign exchange predictions must be published. Deadlines exist, even if the fog disguising the future refuses to lift. What have are experts predicted, on average, once again? Would you believe that they see the Almighty Dollar as becoming less almighty, again? I kid you not. Their guesstimates are based, once again, on a presumption that, as the U.S. economy weakens, the rest of the world will catch up, and the Fed will soften its hawkish normalization stance. Here is a summarization of what they say the future holds:
It appears that are experts cannot accept defeat. They seem to be doubling down on last year’s bet, in hopes that a large reversal will make them right, if only a year late. The Long-Dollar position was one of the most crowded trades of 2018, but the assumption here is that a major “squeeze” will occur across the board in every pairing. The only questions are when will capital begin to shift allegiances and where will it go?
Even if our indomitable forecasters are off by a similar amount as with 2018 predictions, the greenback would still fall by some 3.1%. There have actually been several articles in the financial press that are asking when to begin shorting the USD, but the figures above are making a few rather large leaps of faith. Europe’s economy still seems stuck in a low gear, with the possibility of moving to an even lower one. A “no confidence” vote on the initial plan for a complete Brexit was voted down heavily in Parliament, but these assumptions presume a “happy” divorce from the EU, if you will. The two commodity currencies, the Aussie and the Loonie, could rebound, as long as China and the U.S. get along smoothly at the trade table and oil demand picks up significantly.
What are the narratives for each country pairing driving these rate predictions?
As Confucius was wont to say in such situations: “Study the past if you would define the future.” In that regard, let’s take a quick look at what actually transpired last year:
Central bank policy divergence was still the primary theme for the year. The Fed did not back off its rate hikes, while other central banks balked at even beginning to normalize their respective rates and balance sheets. Commodity currencies succumbed to weaker demand, and the Yen and USD benefited from capital flight following the crisis in emerging market countries. The USD index stands at 96.4, just over its yearend figure.
One analyst summed it up as follows: “International investment opportunities have been crowded out by a stronger dollar and an outperforming US equity market. Like a noisy dinner party guest, Washington has dominated the macro-political conversation.” Going forward, however, there are no funds left for “late-in-the-game” stimulus programs.
The consensus narrative for last year, however, read as follows: “The consensus view heading into 2018 is that the U.S. dollar will continue weakening and may fall below the bottom end of its three-year trading range. With economic growth in the U.S. still strong relative to the rest of the world and the Fed potentially increasing the pace of its already steady monetary tightening in what is still the global market safe haven, a reversal toward sustained strengthening in the U.S. dollar should not be ruled out for 2018.”
Analysts are once again forecasting that the Dollar will weaken, perhaps, for different reasons, but they are pointing toward “the bottom end of its three-year trading range.” There is general agreement that the U.S. economy is weakening. A recession always seems to be four quarters in the future, but none of the creditable recession models are predicting a drastic retraction any time soon. The issue is debt and a continuing deficit, which was used as stimulus during the latter part of this economic cycle, a policy that was criticized by economists the world over.
Postulating that the U.S. economy will contract in 2019 is a starting point in every analysis that we have seen to date. The question is can the rest of the world pick up the slack or will we see a repeat of last year, i.e., déjà vu all over again. We are at the end of a major debt cycle, and articles on this topic typically paint a scenario where the demand for Treasuries drops and central banks seek alternatives to the USD for their all-important trade reserves. The only issue with this argument is that the decline in support of the U.S. Dollar from a reserve perspective has been minimal.
Analysts’ comments for each country follow:
A common analyst refrain is: “After registering solid gains 2018, the trade-weighted U.S. dollar is set for a giveback. A moderation in the pace of monetary policy tightening by the Federal Reserve coupled with the return of risk taking, after the global stock market rout of Q4, should take some steam out of the greenback in 2019”.
Opinions are mixed on the Euro, but this comment seems to summarize the outlook: “Our constructive EUR/USD outlook for 2H19 is more about a negative US dollar view than a bullish euro call.”
Brexit discussions have beaten down the Pound. Bank of America believes that, “Sterling is currently significantly undervalued, by 15-20%, offering the potential for substantial returns for long-term investors”. A rate of $1.405 is very speculative, since, depending upon which Brexit scenario is chosen, forecasted rates vary anywhere from 1.10 to 1.59.
Japan will continue to muddle along: “We expect the JPY to strengthen modestly against a broadly softer USD this year but to under-perform against the EUR and GBP. The Bank of Japan is liable to maintain policy accommodation for some time to come.” One also can never underestimate how much investors favor the Yen in times of uncertainty.
As always, so goes China, so goes the Aussie. 2019 will be no different: “The Australian Dollar remains vulnerable to global trade concerns while internally, a wallowing housing market threatens to dampen economic projections. A positive conclusion to the US-China trade war is the most likely upside boost to the AUD in the coming quarters.”
The Loonie is inextricably tied to oil prices, a fact that was borne out by the final quarter of 2018 when oil went into a tailspin. Most analysts see a similar recovery of oil and the Loonie in 2019: “The Canadian Dollar’s oil-prompted depreciation looks set to alleviate as production cuts internally and from OPEC+ members provide support for Brent Crude prices into 2019. Economic growth outlooks remain positive and BoC hikes look set to keep pace with the Fed.”
Will the USD capitulate and comply with the general consensus for 2019 – a gradual weakening versus other major forex pairings? At some point, debt, deficit, and current account balances will pull the greenback off its high perch and back into the realm of reality. But – Will comparative differences cause depreciation or more appreciation?
The jury is out. Do you short the USD? What do you think?