2018 FX Outlook Happy Hour! - Economic and Financial Analysis - ING Think
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FX Outlook 2018 December 2017
Economic and Financial Analysis
December 2017
2018 FX Outlook
Happy Hour!
FX Strategy Team
research.ing.com 1
SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION
FX Outlook 2018 December 2017
2018 FX Outlook: Happy Hour!
• Despite the threat of President Trump’s policy-by-Twitter approach, global policy
uncertainty has fallen in 2017. The world has seemingly learned to live with Trump
• Fears of central bank liquidity withdrawal look overplayed. A broadening business
cycle will also favour those currencies benefiting from firmer investment trends
• In all we look for one more year of investors chasing growth stories in the FX
space. 2019 looks tougher, however, so let’s enjoy it while we can
This time last year, the dollar was rallying on the view on the view that Donald Trump
was going to unleash the kind of fiscal stimulus not seen since the Reagan years.
Chris Turner Whether he was going to deliver on his protectionist campaign rhetoric was anyone’s
Global Head of Strategy guess. But the backlash against globalisation evidenced in the Trump and Brexit votes
London +44 20 7767 1610
chris.turner@ing.com
had certainly elevated levels of policy uncertainty ahead of key elections in Europe.
At the same time, markets were also starting to question whether the withdrawal of Fed
stimulus was going to expose some unexpected dollar dependencies – such as the
excessive credit growth in the likes of China or Turkey. Would Fed balance sheet
normalisation also deflate the financial asset bubbles in the making since 2009?
Investors were also asking whether global growth would broaden or whether the rest of
the global economy hoped to dine out on US consumption – potentially creating a head-
Viraj Patel on collision with Trump’s ‘free and fair’ policy for global trade?
Foreign Exchange Strategist
A year ago we had described the above environment as the global economy entering a
London +44 20 7767 6405
viraj.patel@ing.com Brave New World, an environment of opportunity and uncertainty.
The good news, one year on, is that opportunities have been taken, while uncertainties
have decreased. Global consumer and business confidence is on cycle highs and most
asset classes have recorded stellar returns. And for the first time since the Global
Financial Crisis, higher global growth forecasts now look credible.
Fig 1 2018 global growth outlook looks relatively cheerful Fig 2 Global ‘Animal Spirits’ running at post-crisis highs
IMF World GDP estimate (percent change) Diffusion index
After years of persistent Higher number = Greater synchronised positive confidence across countries
5.5
downgrades, the IMF now see 1.5 Global 'Animal Spirits'
global growth bottoming out Global business and
5.0 Sep-11 and in fact nudged the 2018
1.0 consumer confidence
outlook slightly higher
Oct-12 running at post-GFC highs
4.5
0.5
Oct-13
Oct-14
4.0 Oct-15
Oct-17 0.0
3.5 Oct-16 -0.5
2018 World Growth
3.0 3.6% -1.0
Business Confidence Consumer Confidence
Less than 2-2.5% world growth ≈ global recession
2.5 -1.5
2010 2012 2014 2016 2018 2020 2022 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: IMF estimates, ING Note: Diffusion indices based on a sample of 25 DM & major EM economies
Source: Macrobond, ING FX Strategy
1
FX Outlook 2018 December 2017
Where will 2018 mark in the global business cycle? ‘Happy Hour’ seems the most
appropriate description. Broadening growth and low inflation should remain a wonderful
cocktail for risk assets. But like all good ‘Happy Hours’, the window for enjoyment is
limited. As the US cycle matures and G3 central bank balance sheets start contracting,
2019 will provide much stiffer headwinds.
It is in this context that we examine the key FX challenges for 2018, looking through
the lens of: (1) declining policy uncertainty; (2) the changing composition of global
liquidity; and (3) the broadening and maturing of the global business cycle.
Assumption 1: Policy uncertainty falls
Despite the occasional scares from Trump’s twitter account, measures of policy
uncertainty have actually fallen substantially over the last year. The Global Economic
Policy Uncertainty index (GEPU), for example, scans newspapers in 18 countries for
terms relating to the Economy, Policy and
“ It should be no surprise that risky Uncertainty. Having peaked in January 2017,
currencies are performing well, even as this index is off sharply as the world has
major central banks ease up on liquidity ” seemingly learned to live with Trump.
Supporting these moves has been the greater
confidence in economic forecasting as represented by the narrower dispersion in GDP
forecasts. Lower uncertainty lowers financing costs, raises asset prices and, as we shall
discuss later, encourages investment.
On a relative basis, we note some particularly large falls in these uncertainty indices for
the likes of Eurozone, the UK and Mexico. The Eurozone fall should be no surprise given
the failure of Le Pen in the French Presidential elections and growing business
confidence. And that improvement was embodied in President Draghi’s June speech in
Sintra – effectively signalling the all-clear on the Eurozone crisis raging since 2010.
Fig 3 Peak global uncertainty looks to be behind us now Fig 4 Synchronised fall in uncertainty across the majors
Global Policy Uncertainty and Geopolitical Risk Indices Economic Policy Uncertainty Index
Peak uncertainty* Latest
(+ve value = above norm uncertainty)
Geopolitics (lhs) Policy Uncertainty (rhs)
525 250 6
Jan-17
5
450 Mar-17
150 Jan-17 Nov-16
4
Jan-17
375 Jan-17
3
300 50
2 Nov-16
225 1
-50
0
150
-150 -1
75
-2
0 -250
2005 2007 2009 2011 2013 2015 2017
Source: Baker, Bloom and Davis (2014); Caldara and Iacoviello (2017) *Peak was in June 2016 unless stated. Chart shows normalised scores.
Source: ING calculations using Baker, Bloom and Davis (2014) data
Into 2018, Italian elections are probably the biggest source of Eurozone uncertainty
through the early part of the year. Our team believe the elections will probably take
place in March and notionally assign only a 30% probability to an outcome that could
create greater uncertainty such as the need for new elections or anti EU coalition of 5SM
and Lega Nord gaining power.
German politics will also be a major feature at the start of 2018. As we go to press our
German team assigns these probabilities to the three main scenarios: (1) CDU/CSU form
a grand coalition with the SPD, for the ‘price’ of greater European reform (40%);
2
FX Outlook 2018 December 2017
(2) Merkel is left to form a minority government, which would likely fall within twelve
months (30%); and (3) fresh elections (30%).
Brexit will, of course, continue to play a role in the broader uncertainty index. Our
baseline view here is that UK authorities, belatedly understanding the economic realities
of a Hard Brexit, make the necessary concessions to secure Phase II of the Brexit process
this December. This should help keep the Brexit uncertainty risk contained in the early
part of 2018, although another robust debate about the shape of a future trade deal
may emerge towards the end of 2018.
Fig 5 2018 political calendar still looks fairly eventful… but the risks are more local
Chile Italy Russia Colombia
Second round General election Presidential election Congressional election
presidential election March 2018 (probable) March 2018 March 2018
December 2017
“ Bar the Italian and US
mid-term elections, the
2018 political calendar Malaysia Mexico Colombia Hungary
sees more local – rather Parliamentary General election Presidential election Parliamentary
election
”
July 2018 May 2018 election
than global – risks August 2018 April 2018
Sweden Brazil Unites States Thailand
General election General election Mid-term elections General Election
September 2018 October 2018 October 2018 November 2018 (probable)
Source: ING
We will also see mid-term elections in the US and Presidential elections in Russia, Brazil
and Mexico. Our team feel that some modest tax cuts and 3% US growth may be
enough for the Republicans to maintain control of both houses of Congress.
Of the Presidential elections, our team feel that those in Latam could generate the
greatest turbulence. At this stage, though, we doubt they will have global ramifications.
Lower policy uncertainty has also been helped by the well-telegraphed and seemingly
synchronised policies of some of the world’s largest central banks. This has been
evidenced by the greater co-movement of bond yields – and has also sent G7 FX
volatility down to its lowest levels in three years.
We continue to see policy uncertainty remaining at its more subdued levels into
2018. But will the synchronised slowdown in central bank balance sheet growth
start to create problems for those currencies dependent on global liquidity?
Assumption 2: Liquidity fears look exaggerated
When it comes to the some of the biggest challenges to the investment environment in
2018, one of the most commonly cited is the withdrawal of central bank liquidity. After
all, the Quantitative Easing policies employed by central banks were heavily skewed
towards driving investors down the credit curve and into riskier assets.
ING’s Chief Eurozone economist, Peter Vanden Houte, wrote an article on this subject
entitled ‘The next Minsky Moment’ on ING’s new THINK website. While history is not
always a good guide, we do agree with Peter’s conclusions that the withdrawal of
central bank liquidity is more likely to prove a threat to asset markets in 2019 than 2018.
3
FX Outlook 2018 December 2017
We also believe two factors will be important in creating benign investment conditions
through 2018:
• Aggregate central bank balance sheet will still grow in 2018
• Private sector liquidity will compensate for declining official liquidity provision
Fig 6 Central banks will begin to withdraw liquidity in 2018… but ever so gradually
Balance Sheets of Major Central Banks (12m change, USD trillion)
ING forecasts
US Japan
3.5 Euro Area UK
Switzerland China +ve = net expansion
3.0
Other * Total CB Liquidity of CB liquidity
2.5
“
Central banks still
Aggregate balance sheet 2.0 adding to global
liquidity in 2018
of the world’s largest 1.5
central banks will not 1.0
start contracting until 0.5
after summer 2019 ” 0.0
-0.5
-1.0 -ve = net contraction
of CB liquidity
-1.5
2011 2012 2013 2014 2015 2016 2017 2018 2019
Note: Other includes Brazil, Russia, India and Sweden
Source: Macrobond, ING estimates
As Figure 6 shows, the growth in official sector liquidity is certainly going to slow in 2018.
The Fed have become experts in unwinding their legacy QE programmes and have a
well-telegraphed balance sheet reduction plan. In theory that could see a maximum
US$50bn per month decline in the Fed balance sheet being enacted by 4Q18.
The ECB are also learning from the Fed’s successful experience with tapering. At present
we assume PSPP is cut to €15bn per month for the final quarter of 2018, before being
stopped completely. For the BoJ, its Yield Curve Control scheme has seen JGB buying
decline by JPY20tr over the last 12 months. We assume another small decline in JGB
buying in 2018.
Other marginal contributors to our aggregate central bank balance sheet chart, eg, the
likes of China, Brazil, Switzerland and Russia, are not expected to have a meaningful
impact on broad trends. We acknowledge this relies on a benign international
environment (meaning that USD/EM does not surge and prompt defensive FX
intervention from local central banks) and that a EUR recovery can keep the SNB away
from the market.
In sum, we do not look for the aggregate
“ Remember, for G3 central banks this balance sheet of the world’s largest central
is a voluntary withdrawal of liquidity ” banks to start contracting until summer 2019 –
suggesting that the headwinds to risk assets
may not stiffen before late-2018. It’s also crucial to remember that for G3 central banks
this is a voluntary withdrawal of liquidity. Were we to see a sharp equity correction or a
geopolitical shock, the Powell-Fed would no doubt slow balance sheet reduction.
4FX Outlook 2018 December 2017
Fig 7 USD cross-border credit to start growing again? Fig 8 Private sector funds under management
30 Total client assets (US$ trn) Pension funds
350 Insurance companies 120
25
Sovereign wealth funds
20
300 HNWI
15 100
Mass affluent
10 Global AuM (rhs)
250
5 80
0
200
-5
60
-10 150
-15
40
2000 2002 2004 2006 2008 2010 2012 2014 2016 100
Total USD credit to non-bank borrrowers in EM economies (% YoY) 50 20
International bank claims on all sectors (%YoY) 0 0
2004 2007 2012 2013 2014 2015 2020F
Source: BIS Source: PWC
Even though the term ‘liquidity’ is much maligned, the BIS have written several articles
over recent years on how to define private sector liquidity. The disintermediation and
de-leveraging of the global banking system has seen one of the key measures of global
liquidity, cross-border interbank claims, stagnate since the Global Financial Crisis.
But debt issuance has surged and one could argue that greater confidence in global
growth, unleashing those animal spirits, could see cross-border USD lending continue its
slow recovery. Notably the increase in USD lending to EM a decade ago help fund
stronger EM growth rates, EM currency rallies and the broad dollar decline.
A much neglected side of private sector liquidity is the strong growth of client Assets
Under Management (AUM). Surely this explains why the exceptional global rally in
equities has been accompanied by generally high readings for investor cash ratios?
For reference, PWC estimates that global AuM are going to rise to US$112tr by 2020
from US$85tr today and US$78tr in 2015. As a share, passive investment strategies are
expect to rise to 21% in 2025 from 14% in 2015. The OECD notes in its latest outlook, ETF
funds under management have surged 27% this year to US$4.3tr.
These trends have been driven by a number of factors, including ageing of OECD
populations and the shift towards funded/defined benefit contribution plans. This trend
looks unlikely to change anytime soon – indeed regulatory changes in the UK and
Australia are directing increasing amounts into funded pension schemes. These trends
should help to soothe the withdrawal of official sector liquidity.
Fig 9 Signalling effect of QE policies & risk appetite… Fig 10 High external deficit countries at risk to QE unwind
Change in MSCI EM FX (y-axis) vs. Change in G3 CB Balance Sheets (x-axis) FX change over Oct-17 (y-axis) vs. 2017 Current Account/GDP ratio (x-axis)
25% 2%
Pre-QE era Post-QE era HKD ILS
20% KRW
0%
MYR
15% Central bank balance sheet
policies operate primarily -2%
10% RUB
via the signalling channel
5% -4%
COP
HUF
0% BRL
-6%
2008-2009
-5% Financial Crisis MXN
-8%
-10% ZAR
-10% TRY
-15%
-20% -12%
-10% 0% 10% 20% 30% 40% 50% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0%
Source: Bloomberg, ING estimates Note: FX performance taken from 9 to 31 October
Source: Bloomberg, Macrobond, ING
5FX Outlook 2018 December 2017
It’s really hard to find a strong statistical relationship between central bank balance
sheet adjustments and, for example, risk-sensitive EM currencies. In fact, the more
convincing relationship seems to be via some sort of ‘signalling channel’ – that is G3
central bank balance sheets tend to grow
“
It should be no surprise that risky during sharp economic slowdowns, which is
currencies are performing well, even as obviously associated with a bear market in
major central banks ease up on liquidity ” risky assets. It should be no surprise that risk-
sensitive currencies are performing quite well
now, even as major central banks ease up on liquidity. Global growth matters more.
A word of warning, however. The performance of some of the EM high yielders over the
last couple of months – albeit driven by local stories – provides a preview of what a
sudden stop of portfolio financing could mean for FX markets.
We would expect headwinds to portfolio flows to become stiffer as 2018 progresses and
thus investors will need to be more nimble with carry strategies. Instead we would prefer
those pro-cyclical currencies, backed by stronger external positions, that can flourish
during the 2018 extension of generally benign liquidity conditions.
We don’t see too many threats from the withdrawal of official sector liquidity – at
least through 1Q18-3Q18. Rather than pursuing high yield FX (many undermined by
local politics), we prefer pro-cyclical FX backed by external surpluses.
Assumption 3: Investment trends key for FX in 2018
The global expansion heading into 2018 looks to be broadening out – and after years of
remaining depressed, the conditions for a pickup in investment are fairly ripe given the
sweet spot of lower political uncertainty from the 2017 peak, easier financial conditions
and greater global ‘animal spirits’.
A goldilocks global economy – one where growth picks up but inflation remains fairly
benign and orderly – underpins our assumptions for global markets in 2018. Sizable
output gaps suggest very few economies are running hot – and the risk of a marked
pickup in inflation remains low – bar a few economies such as the US. Even for the US, a
marked upside break-out in inflation has to be marked as an ‘extreme alternative’.
Fig 11 ING Economic Cycle Dashboard: World economy likely to remain in ‘Goldilocks’ mode given negative output gaps
Economic cycle characteristics exhibited by economies in 2017 Output gap estimates for select countries (% of potential GDP) ING assessment of
3.0 1.5 economic cylce
Stagflation Reflation
MXN Majors Emerging Markets
SEK
2.0 1.0
2017 inflation surprise (ppts)
USD
GBP 0.5
1.0 GBP
NZD
CHF SEK CNY CNY
Late cycle risks
0.0
0.0
USD CAD
AUD EUR
CAD -0.5
-1.0 ZAR NOK KRW World -0.25%
-0.30% EUR
INR -1.0 PPP-weighted
RUB PPP-weighted
JPY average
-2.0 average KRW
-1.5 BRL
Slowdown BRL Goldilocks
-3.0
-2.0 JPY
-1.5 -0.5 0.5 1.5
2017 GDP growth surprise (ppts) AU JP EU CA UK US SW KR IN MX RU ID CN TH TR
Note: Left hand chart shows the revision to IMF country forecasts for inflation and growth between April 2016 and October 2017
Source: ING, IMF.
However, even in a synchronised global growth backdrop this won’t be a free-ride for all
countries. Investors still want to chase positive local growth stories and in 2018, in
particular, will want to chase stories related to the pick-up in investment. This is because
6FX Outlook 2018 December 2017
both corporate profitability and capex intentions are on the rise. So too are IMF forecasts
for investments as a share of growth in 2018.
For FX markets, the differing stages in the economic cycle will mean that not all will
benefit from this investment story. Following up on well-received scorecards on themes
such as the 2015 CNY devaluation, Brexit, Trump and Eurozone politics, we are now
introducing an Investment Scorecard for FX.
Inputs into the scorecard are factors such as business confidence, the manufacturing
intensity of an economy, corporate profitability and the expected change in investment
in 2018. This scorecard is largely illustrative but, in our opinion, provides a great sense of
the winners and losers during the 2018 investment cycle.
Fig 12 ING Investment Dashboard: Conditions look ripe for a synchronised pickup in global activity, but who benefits?
ING Global Manufacturing Diffusion Index Corporate profitability recovering in aggregate Change in IMF estimate for 2018 investment
0.7 20 RUB
18 CAD
0.6 16 CLP
14 KRW Countries where the
0.5 12 2018 investment
EUR outlook has been
10 SEK upgraded recently
0.4 Synchronised pickup 8
in manufacturing NZD
activity across 6
CZK
0.3 major economies 4 Emerging Markets
TRY
2 Majors
COP
0.2 0
2002 2004 2006 2008 2011 2013 2015 2008 2010 2012 2014 2016 0.0 0.5 1.0 1.5
ING Investment Scorecard: Which countries look set to benefit from a synchronised pickup in global industrial activity?
Higher number = Greater sensitivity to a pickup in the global investment cycle
Business Confidence
1.0
Manufacturing Intensity
Corporate Profitability
2018 Investment Outlook
0.5 ING FX Score
0.0
-0.5
-1.0
KRW RUB CZK EUR CAD SEK TRY HUF CNY PLN CHF IDR GBP MXN JPY CLP USD NOK MYR SGD RON NZD THB COP BRL ZAR PHP AUD INR
Note: Our ING Investment Scorecard looks at four characteristics for each country: (1) change in domestic business confidence indicator over the past 6M; (2) the
contribution of the manufacturing sector to GDP; (3) the change in return on equity for domestic stocks; and (4) IMF revision to 2018 total investment forecast.
Source: ING, IMF, Bloomberg, Macrobond
European currencies look good on this basis, as do parts of Asia. Despite synchronised
global growth, the commodity producers do not score impressively. This should not be a
surprise in that this is not a China-driven terms-of-trade story.
Indeed growing investment and the firing up of the manufacturing sector will expose
economies like Australia, that have struggled to diversify away from reliance on
commodity exports.
As the business cycle matures and investment trends improve, investors should
favour the currencies of those economies set to benefit the most from this story.
The outperformers on our scorecard are generally European and Asian currencies.
7FX Outlook 2018 December 2017
The ‘Sweet Spot’ for FX in 2018
Bringing together our three themes of: (1) reduced policy uncertainty; (2) supportive
liquidity conditions supporting pro-cyclical currencies; and (3) a bullish turn in the
investment cycle, we create a venn diagram to identify the sweet spot for FX.
Meeting all our criteria for this 2018 thematic are many European currencies. In general
the EUR and the CE3 currencies look well-placed to benefit from the environment we
describe for next year.
Another year of strong growth in the Eurozone should allow EUR/USD to work its way
towards 1.30, even though the US economy may be growing quite nicely. A tightening
cycle underway in the Czech Republic should allow CZK to outperform the EUR –
delivering healthy gains against the USD.
In Asia, we particularly like the KRW story. The early stage recovery, the tightening cycle
and Korea’s exposure to the global manufacturing cycle should all help USD/KRW to drop
to the 1000 area.
Holding back some currencies that should perform well on the lower uncertainty and
reasonable liquidity story is the exposure to the investment cycle. Here India, Australia
and the Philippines score poorly; consequently our 2018 FX forecasts see their currencies
underperforming their peers. MXN and BRL will be held back by political uncertainty.
Combining our assumptions for: (1) subdued policy uncertainty; (2) ongoing support
to the global recovery from liquidity conditions; and (3) a rotation into investment
stories, we see Europe and Asian FX currencies generally out-performing. The
commodity bloc looks mixed and typically favoured high-yielders lag on politics.
ING 2018 FX Outlook
ING
G Investment
1.1
Scorecard
est e t Sco eca d Finding the ‘Sweet
Finding Spot’Spot’
the ‘Sweet to invest in 2018
in 2018
FX performance in Oct-17 (y-axis) versus
Current account balance % GDP (x-axis)
0.6
3
Linked to global 4%
investment cycle MYR
HKD ILS KRW
0%
0.1
CAD TRY RUB
COP -4%
PLN HUF
-0.4
BRL
KRW RUB CZK EUR CAD SEK TRY HUF CNY PLN MXN -8%
ZAR
KRW RUB TRY
HUF Sweet Spot
-12%
EUR
Economic Policy Uncertainty X CNY -6% -3% 0% 3% 6%
(-ve = lower uncertainty) SEK CZK JPY
EZ GBP 2
UK MYR
JP AUD CHF
CN
CA
AU Lower domestic Low external BRL
MXN
SW political risks imbalance risks
BR ZAR
RU
IN 2018 ‘Outsiders’
1
SK Conventional high-yielders
MX saddled by local politics
Source: ING
We are particularly grateful to Carlo Cocuzzo, ING research analyst based in London,
for his contributions to this article
8FX Outlook 2018 December 2017
Disclaimer
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