A managing transition will be a key theme during 2021 and the degree of success in managing these changes will be crucial for currency markets. There is likely to be a further gradual increase in the US and global interest rates as global economies finally return to more normal conditions.
The UK and Euro-zone also have to manage the process towards a UK Brexit and the outcome will have very important implications for both Sterling and the Euro.
- The US economy is likely to enter 2021 with a stronger growth tone, primarily due to still notably low-interest rates and easy financial conditions.
- The weaker dollar tone seen during 2017 will have an impact in raising the inflation rate and concerns surrounding low inflation are likely to fade, especially with a very tight labour market.
- Fiscal policy will remain an important focus as the US Administration has so far been unable to deliver fiscal reform and tax cuts.
- The most likely outcome is that a package of tax reform and cuts will be delivered by early 2018. If taxes are cut, there will tend to be a further boost to US growth trends during the following year.
- In this environment, there would be additional pressure on the Federal Reserve to tighten policy with interest rates moving significantly higher.
- There is also the potential for legislation to encourage or force US companies to repatriate funds held overseas. This could be a very important factor in drawing capital back to the US and putting upward pressure on the dollar.
- An important factor will be the choice of Federal Reserve chair with Yellen’s current term due to expire in January 2018. There are also several vacancies on the FOMC and there is the opportunity to substantially re-shape the committee.
- The re-appointment of Yellen would be positive in that it would maintain continuity, while there would be expectations of a slow and gradual tightening.
- The appointment of a more dovish candidate would tend to undermine the dollar while a more hawkish tone would offer US currency support, at least in the short term.
- Overall, the economic risk profile is likely to gradually increase during the year.
- Range trading is likely – look to buy any sharp losses
- The Euro-zone economy should maintain strong growth early in 2021 with further momentum from the very loose monetary policy that has prevailed over the past 2-3 years.
- The ECB policies will be a key focus and there is a strong probability that there will be a removal of some policy accommodation during the year. There is likely to be a gradual decline in bond purchases with the quantitative easing program completed during the year, although it is also the case that interest rates are likely to remain at very low levels.
- Political factors will be important, especially with German Chancellor Merkel in a weakened position following the Federal Election. Merkel is likely to put a coalition together, but it will be less cohesive and Euro-zone reform momentum is liable to stall.
- There also still the risk that political stresses will erupt again in Italy with the probability that a general election will be held during the year.
- In this environment, there is a risk that Euro sentiment will deteriorate sharply again.
- Look to sell strong Euro rallies.
- Uncertainty will again be a crucial element surrounding the 2021 UK outlook with important political and economic variables with a Brexit deal needing to be completed by late 2020 in order to ratify a deal by early 2021.
- Investment levels are liable to remain subdued given the negative impact of Brexit negotiations
- Consumer spending trends are also liable to remain relatively subdued given the weakness in real wages, but strong employment trends will offer support.
- The Bank of England is likely to remain relatively cautious over the outlook, but there is the potential for a small increase in interest rates.
- There is also the risk of a more substantial increase in inflationary pressure which would increase pressure for a more aggressive Bank of England policy tightening and notably higher interest rates.
- In this environment, the economy could slow sharply late in 2018.
- These risks will intensify if there is a breakdown in Brexit talks. In contrast, an agreement for transition arrangements and evidence of a deal on exit terms would provide important relief.
- There is still a very important risk that there will be a destabilising General Election and another change in Conservative Party leader.
- The most likely outcome is slight Sterling gains for the year, but with a significant risk of heavy and sustained pressure.
- Buy any substantial Sterling moves lower.
- Prime Minister Abe has called an election for October and the LDP party is likely to secure re-election given a divided opposition. The most likely outcome, however, is that there will be a continuation of current policies.
- The Bank of Japan will also maintain a very expansionary monetary policy with a continuation of the bond-buying programme.
- There will, however, be important concerns whether the programme is sustainable given the number of bonds held by the central bank. There is an important risk that increased doubts over quantitative easing will see strong short-term upward pressure on the yen. Sell yen rallies.
- The Chinese economy has maintained firm growth during 2017 while a recovery in the yuan has eased pressure on monetary policy.
- There will still be important risks to the outlook, especially given the very high level of debt and persistently rapid credit growth in the economy.
- The People’s Bank of China will continue to face a tough task in balancing economic risks. There is still an important risk that the economy will slide into recession during the forecast period.
- There should be a further transition period during 2018 with the gradual move towards a tighter monetary policy by global central banks as there is a more sustained move towards more normal conditions following the exceptionally loose policy seen over the past few years.
- One particularly strong currency is proving to be the Israel Shekel and although it is strengthening, the local real estate market is ever so strong.
- The global economy’s ability to cope with this transition will be a key factor and there will be important concerns surrounding the impact of extremely high debt levels in historic terms.
- There is an important risk that there will be a sharp slowdown in growth and slide towards global recession as the number of borrowers in serious difficulties increases sharply.
- Media attention surrounding the grand jury investigation into Russian involvement in the 2016 US elections has faded for now, but there is still a risk that President Trump could be impeached which would be liable to weaken the dollar sharply.
- North Korea will remain a significant background focus and any military action in the region would trigger a spike in demand for defensive assets including the Japanese yen.
- The French election result was important in easing underlying tensions, but there is still a risk that another Euro-zone political crisis will develop.
- Similarly, there will be an important risk that Brexit talks will collapse as both sides pursue a policy of brinkmanship. Such an outcome would lead to sharp selling pressure on Sterling and the Euro.
- Equity-markets remain very highly valued and there will be a risk of a sharp slide which would undermine risk conditions.
Summary: FX Forecasts 2021
- The global economy should perform well early in 2021 with support from the previous expansionary monetary policy seen over the past 2 years.
- The outlook is, however, likely to become more challenging during the year as interest rates gradually increase across all the major economies.
- Political factors will be very important for the UK and also have an important impact on the Euro-zone during the year.
- Overall, there is liable to be a high degree of volatility during the year and potentially major tail risks surrounding all major economic areas, especially the UK and China.
- The dollar should be able to maintain a generally robust tone, especially if there are capital flows back to the US on tax changes.
|Currency pair||Spot rate||End-2021 forecast||Suggested strategy||Suggested strategy|
|EUR/USD||1.1880||1.1200||Sell near 1.2500||Buy below 1.1000|
|USD/JPY||112.00||120.00||Buy near 105.00||Sell near 125.00|
|EUR/GBP||0.8800||0.8100||Sell near 0.9200||Buy near 0.7800|
|GBP/USD||1.3510||1.3830||Sell near 1.4200||Buy near 1.2500|
|EUR/CHF||1.1570||1.1800||Buy near 1.1000|
|USD/CHF||0.9730||1.0540||Buy near 0.9500|
|EUR/JPY||133.10||134.40||Buy near 120.00|
|GBP/JPY||151.3||165.90||Buy below 140.00|
|EUR/AUD||1.4930||1.6000||Buy near 1.4200|
|EUR/CAD||1.4650||1.4900||Buy near 1.4000|
|AUD/USD||0.7960||0.7000||Sell near 0.8200|
|USD/CAD||1.2330||1.3300||Buy near 1.2000|
|NZD/USD||0.7280||0.7000||Sell near 0.7500|
|USD/CNY||6.6200||7.1500||Buy near 6.6000|
|USD/MXN||17.90||18.70||Buy near 17.00|
|USD/BRL||3.1400||3.3200||Buy near 3.1000|
|USD/SGD||1.3500||1.4000||Buy near 1.3300|
|USD/TRY||3.5200||3.6500||Buy near 3.3000|
|USD/HKD||7.8100||7.8000||Buy near 7.7500|
|USD/SEK||8.0000||7.7500||Sell near 8.2500|