The major themes I expect to be moving the forex market in 2014 are: the Federal Reserve’s tapering and its impact on the global economy; exceptionally low inflation, especially in Europe, but elsewhere as well; the change in European banking regulation; the decision on whether Abenomics is working; less restrictive fiscal policies in the G10, resulting in stronger growth; and the restructuring of the Chinese economy.
There are long-term trends in the forex market that last over a number of years (see Fig. 1). This graph shows the value of the dollar since it began floating, first against the Deutsche Mark, and then against the euro. The big question is whether the dollar is still in the uptrend that started in May of 2008, or whether it began a new downtrend last July. My view is that we’re still in the uptrend and this year we’re likely to see the dollar rally further.
The reason for that goes back to this year’s themes. Only the Reserve Bank of New Zealand is currently expected to tighten in 2014. Every other central bank is expected to keep policy steady. The RBA is expected to go next when it begins tightening in about a year, then the Fed, ECB and BoE are all expected to start around 18 months from now, followed by the Swiss National Bank two years from now.
The Bank of Japan isn’t expected to begin tightening even in three years. With rate differentials expected to remain so stable for so long, investors will be watching the economic data closely to see if any economy starts growing fast enough that the central bank might be able to start changing its stance earlier than expected. So growth rates will be key.
Race to the top
New Zealand and Australia are expected to be the fastest-growing countries in the G10 next year, which is why their central banks are expected to start tightening first. The US and the UK are next. I think that if these forecasts come true and US growth does improve that much, then the market will start to discount an earlier hike in interest rates in the US. That’s what is going to support the dollar, in my view.
Same thing with the pound. Forecasts for Britain’s growth in 2014 are about the same as for the US, although UK growth was lower this year. In other words, Britain should see an even bigger improvement in growth than the US. That’s likely to support the pound, at least against the euro. I think the dollar will still gain against the pound.
This is because I expect Britain’s inflation rate to remain exceptionally low, just like the rest of Europe. The BoE is likely to take advantage of the low inflation to keep rates lower for longer than they would have otherwise. That’s how the government will manage the fiscal retrenchment that they’re planning. The only problem is that British growth is based on borrowing and consuming, not investing and producing. On average, every adult in the country owes £28,489. There’s a limit to how long this can continue. But that’s probably a topic for 2015, not 2014.
While the eurozone is forecast to see a big improvement in growth this year, the absolute level of growth will still be too low to allow the ECB to even think of raising rates. On the contrary, one of the themes for next year is likely to be dangerously low inflation, particularly in the eurozone. This is directly the opposite of what the US is doing, which is why I expect the euro to weaken against the dollar. Also, next year’s restructuring of the eurozone’s banking supervision mechanism is likely to require that the ECB provides more support to the banks by expanding its balance sheet, which should be EUR-negative.
I think though that the most important currency to watch is the yen (see Fig. 2). This graph shows the ranked returns of the G10 currencies against the dollar each year. You can see that the yen is usually extreme. It’s been either the best or worst performing G10 currency for the last six years, and over the last 11 years it’s never been in the middle. It was the worst performing G10 currency in 2012 and 2013, and it might well wind up there again this year. That’s because 2014 is the year when Abenomics has to prove itself.
Predicting fiscal cause and effect
If Abenomics does start to get traction and the Japanese economy does improve, then Japanese investors’ risk appetite will increase and they’re likely to put more money abroad. That may seem like strange logic, but that’s what happens in Japan. A revival in confidence in Japan would probably cause an outflow of funds and a fall in the currency.
On the other hand, if Abenomics doesn’t start to show results, if it’s just causing consumer prices to rise with no increase in salaries or employment, or if the hike in the sales tax once again causes a recession like it did the last time they raised it back in 1997, then Shinzõ Abe has only one card left to play, and that’s to devalue the currency. In that case I’d expect the Bank of Japan to come out with yet another round of quantitative easing and my target of USD/JPY at 130 might well be reached. That’s not my central case, but I think it’s possible.
As for the CHF, I expect the Swiss National Bank to keep EUR/CHF floored at 1.20. So long as that’s the case, the dollar can’t appreciate against the CHF unless it appreciates against the euro too. But as I said before, I do expect the dollar to gain against the euro – and so I expect it will gain against the CHF too.
Finally, there are the commodity currencies. The Reserve Bank of Australia has stated clearly that it wants the Australian dollar to weaken, and if global inflation falls further, as I expect, the RBA could even cut rates to ensure that this happens.
The Australian dollar might also be weakened as China’s economy shifts away from investment and demand for commodities falls. The Bank of Canada too has removed its long-held tightening bias, and with Canadian households’ debt-to-income level now at a record 166 percent, it won’t be able to raise rates any time soon without bankrupting the whole country.
Also, Canadian oil prices are under pressure as US oil production increases. That’s likely to be a long-term factor depressing the CAD. The New Zealand dollar on the other hand is different. New Zealand has good domestic economic fundamentals and the only G10 central bank that’s intent on tightening. The currency may come under pressure occasionally because of Chinese restructuring, but its exports of food are likely to be affected less than Australia’s exports of minerals.
Marshall Gittler has been an investment strategist for 25 years at a number of major international securities firms, including UBS, Merrill Lynch, Bank of America and Deutsche Bank as well as serving as Chief Investment Officer at Bank of China (Suisse). He is Currently Head of Global FX Strategy at IronFX Global.