A look back at 2018


 

The currency markets have been surprisingly sedate in recent months, particularly developed market currencies. However, 2018 turned out to be another year where the markets defied the consensus forecast and dumbfounded analysts who forecasted a weaker dollar. In traditional fashion, we take this opportunity to look back at how our forecasts fared in 2018 before looking ahead to what we might expect from 2019 in next week’s edition.

 

 

GBPUSD

 

The dollar started 2018 under pressure amid expectations that other central banks (primarily the ECB and BOJ) would start tightening monetary policy in 2018 and as such, the greenback would be less of a stand-out from a yield perspective. As a result, sterling began 2018 at $1.38 – its highest level since the referendum back in 2016 and rallied to a high of $1.43 in April.

 

Unsurprisingly, the consensus forecast was for the weaker dollar trend to continue throughout the year as interest rate differentials narrowed. However, this wasn’t the Validus view. Instead, we favoured the dollar for three key reasons:

 

  1. We didn’t believe that the ECB, BoJ or BoE would be able to tighten policy to the extent that the dollar would start to look less attractive relative to its peers.
  2. A second reason for expecting the dollar to strengthen was companies taking advantage of a one-off tax cut for US companies repatriating earnings and cash held overseas. The impact was never discussed at length, but any impact was only likely to have been positive for the dollar.
  3. Meanwhile, we saw a number of headwinds for sterling and were correct to be sceptical about the prospect for a positive outcome for Brexit negotiations and the Bank of England’s ability to raise interest rates.

 

 

GBPUSD

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Consensus

1.33

1.32

1.34

1.35

Validus Forecast

1.38

1.34

1.32

1.30

Actual

1.40

1.32

1.30

1.27

 

 

EURUSD

 

The euro ended 2017 as the dominant force over the dollar having rallied from $1.16 to $1.20 in the final two months of the year. That theme continued in the first two months of 2018 as the pair touched $1.25 amid expectations that the ECB would start tightening policy and as such, interest differentials would start to narrow. Unsurprisingly, the consensus forecast was for this trend to continue throughout 2018.

 

In contrast, Validus held a contrarian view, believing that the ECB would keep rates unchanged throughout the year and maintain an accommodative stance. We also believed the Fed would continue to tighten policy (the Fed initiated 4x 0.25% hikes) and saw fiscal policy providing the dollar with another tail wind.

 

Fortunately, our instinct proved correct although in hindsight, we could have been even more bearish on the euro / bullish on the dollar as the pair reached a low just above $1.12 in November.

 

EURUSD

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Consensus

1.18

1.19

1.21

1.22

Validus Forecast

1.23

1.19

1.17

1.16

Actual

1.23

1.17

1.16

1.15

 

 

GBPEUR

 

Unsurprisingly, the main influence on the GBPEUR exchange rate in 2018 was Brexit negotiations. After some initial optimism in the first quarter, which was seen again in Q3 (resulting in the pound trading close to €1.16) sterling closed 2018 under a cloud after Theresa May postponed a Parliamentary vote on her Brexit deal for fear that it wouldn’t receive sufficient support in the House of Commons.

 

The one slight surprise was that economic data and the outlook for monetary policy didn’t have more influence on either currency. The UK economy may not have grown quite as quickly as anticipated in 2018, but the Bank of England was still able to hike rates by 0.25% in August. In contrast, the ECB kept rates unchanged and looks set to do the same in 2019 amid signs that economic growth in the Eurozone is starting to slow again.

 

At the start of 2018, we suggested that there was little to provide a clear directional bias for GBPEUR and this proved to be the case with the pair stuck in a range between €1.10 and €1.16.

 

GBPEUR

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Consensus

1.12

1.11

1.11

1.10

Validus Forecast

1.12

1.13

1.12

1.12

Actual

1.14

1.13

1.13

1.11

 

 

USDCAD

 

The Canadian dollar faced a number of headwinds in 2018, many of which were mere rumblings at the beginning of the year, and most forecasters took a long time to recognize the negative impact that these would have on the Loonie. The key factors that weighed on CAD last year were; the NAFTA renegotiations, which put at risk the largest bilateral trading relationship in the region, namely trade between Canada and the US.

 

As Trump took aim at any country with which the US has a trade deficit, the general consensus was the he would be less aggressive towards Canada given the importance of trade with his northern neighbour. These hopes were dashed when, on July 26th, Trump’s Chief Trade Negotiator, Robert Lighthizer called Canada a national security threat to the United States, and slapped tariffs on steel and aluminum. After some bitter battles with nasty tweets, the new USMCA (US-Mexico-Canada) was finally struck, but the terms are less favourable than the previous Nafta deal, and tariffs on steel and aluminum remain in place.

 

The second main headwind to the Canada dollar was the price of Western Canada Select (WCS) oil vs the benchmark West Texas Intermediate (WTI). Due to the failure to increase pipeline capacity to get Canadian oil down to the US refineries, WCS stocks built up and prices declined significantly, with the spread between WCS and WTI as wide as $45/bbl.

 

Both of these factors, plus the continued wide spread between US and Canadian interest rates, have caused CAD to depreciate vs the USD over the course of 2018. While we had a more positive view vs consensus in Q1, we had recognized the risk factors, and we were far more negative on CAD than the market for Q2-Q4 and were one of the most accurate forecasters of CAD for last year.

 

USDCAD

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Consensus

1.26

1.25

1.24

1.23

Validus Forecast

1.25

1.28

1.31

1.34

Actual

1.29

1.31

1.29

1.36

 

In next week’s report, we’ll summarise key themes and our views for 2019. Hopefully we can be as successful as we were in 2018!

 



 

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