2017 – A Turbulent Year

2018 is nearly upon us and the past year was certainly full of interesting events. Potentially dangerous political events in the EU – such as the French & German elections and the Catalan independence referendum – were safely navigated.

Having seen a rise in extremism in 2016, things seemed to calm down in 2017 even though there were plenty of opportunities for escalation. The US administration continued to struggle with the implementation of its agenda, as the long-awaited tax plan was finally passed in December. The US economy marched on exhibiting robust performance, even though inflation remains below target.

2017 was a positive year for the UK, which had been on the back foot since the 2016 European referendum. The economy grew albeit at a moderate pace and inflation & wage growth rose. The Bank of England finally reversed its post-referendum 25bp cut amid growing concerns over rising inflation. The country’s major stumbling block is still the Brexit negotiation process and the associated uncertainty, but some good progress was made in the latter parts of the year.

So, what do I think will be the major themes & events for 2018?

What’s Next?

EUROZONE

For starters, Europe is not out of the woods yet. The Italian elections in spring will be crucial as political parties such as the 5 Star Movement gain more support. A surprise result could easily rekindle anxiety and uncertainty. The German elections still haven’t yielded a firm government but there is little doubt that a robust coalition will be formed. European data has been consistently strong and that should theoretically give the ECB the ease of mind it requires before engaging in monetary tightening. Having said that, there are two major hurdles that need to be overcome before that can happen: (1) Inflation needs to pick up as it remains stubbornly below target (2) The Euro needs to weaken a bit from here, as 1.20 EURUSD has been a notoriously worrying level for Draghi and his crew.

UK

In the UK, the government remains shaky as PM May tries to keep control of a fragile narrow majority. The last thing that the UK needs right now is political uncertainty and new elections, so they will really fight that scenario. On the positive side, we’ve had some solid progress in UK/EU Brexit talks, as acknowledged by both sides. Cynics will say that this is just the tip of the iceberg and a lot of work remains to be done, but the bottom line is that we’re seeing constructive work being done. The size of the UK economy dictates that both sides have a vested interest to agree on a good compromise. My view is that there may be obstacles on the tracks, but the locomotive is slowly moving forward.

US

The US administration needs to deliver the promised reforms and the pace is currently very slow, while the TPP and Paris Agreement exits raised concerns among the global community. The Fed continued its hiking cycle in 2017 and the dot plot shows expectations for 3 more in 2018. The US economy is certainly showing some good potential (strong GDP, very low unemployment and high economic activity) but there are also some question marks. Inflation remains low at 1.5% and the effect of the 2017 tightening still remains to be seen. Hiking into a low inflation environment will apply the brakes further and new Fed chair Powell will be aware of that. My base case for the USD is further weakness into 2018 and this is certainly a possible scenario in the context of global geopolitical threats such as North Korea.

JAPAN

The Yen failed to weaken materially in 2017, despite the BoJ’s best efforts. The Japanese economy is undeniably improving: core inflation is rising and PM Abe will lift sales tax from 8% to 10%. The risk is probably skewed towards Yen appreciation in 2018.

CANADA

The Canadian Dollar weakened on the back of soft inflation but other economic data has been strong enough to justify two 25bp rate hikes in 2017. With oil near the $60 mark, risks remain tilted to the upside for CAD.

NORWAY

The Norwegian Kroner remains totally disconnected from the country’s economic fundamentals. NOK saw major weakness in 2017, even though the economy was steady and oil rallied. The only stumbling block has been falling inflation but that is most likely transitory and cannot justify such extreme currency weakness. Norges Bank has been hawkish, projecting its first rate hike in autumn of 2018 and sticking with solid growth & inflation forecasts.

OCEANIA

Other commodity currencies such as the Aussie and Kiwi are broadly at the same levels as in the beginning of 2017 vs. the USD, and are likely to be rangebound into 2018. The NZD is probably in a more vulnerable spot as it’s going up against two major forces: (1) The RBNZ is very uncomfortable with NZD appreciation, and is quick to voice those concerns (2) The new government has a natural bias towards currency depreciation.

BONDS

Bonds are breaking some key technical downside levels at the end of 2017. Will 2018 be the year of higher bond yields worldwide? Or will central banks continue asset buying and prevent a bond collapse? It’s a complex equation that remains to be seen, but the theme of global gradual tightening is certainly consistent with lower bond prices and higher yields.

PRECIOUS METALS

Precious metals should have performed better in 2017 as the Dollar weakened. Gold is ending the year around 8% higher but Silver actually didn’t manage to post any gains at all. Gold broke the huge $1320-$1340 resistance level but was met with great selling pressure, making it a false break. For 2018 the outlook is positive for PMs as the USD weakens further. It’s quite probable that the resistance level in Gold will be retested, as should the $18.50-$19 zone in Silver.

OIL

Oil probably to continue to grind higher as the production ceiling agreement continues and global geopolitical risks stay elevated. In the US, rig counts are steady and production is increasingly consumed internally. OPEC producers have played the game very well and managed to prop up prices from sub-$30 to nearly $60.

EQUITIES

US stocks remain at lofty valuations and could very well continue for a few months longer. However, there will eventually be a point where a healthy correction will take place. The trigger may be exogenous or it may simply be due to the unwind of record short volatility positions. Either way, the straight-line rise since 2009 is likely reaching a blow-off top which will signal the start of a major leg lower.

CRYPTOS

Crypto-currencies are already showing signs of fatigue and profit-taking. Last week’s sell off was strong and it showed exactly what obstacles arise when everyone starts looking for the exit. The inability of many exchanges to function when overloaded with requests is a serious problem for prospective investors. The key Bitcoin technical level at around $12,000 was breached but it was met with renewed buying. Another breach of that level will confirm that this move lower still has legs, and the capitulation of longs will probably bring more extreme price moves.

Conclusions

My key takeaways are:

  • USD to continue weakening into 2018, perhaps after a slight bounce. We could see 95-96 on the DXY before dropping to the mid-80s.
  • GBP to continue gaining strength as Brexit negotiations continue being constructive and the BoE raising rates further to fight inflation.
  • EUR to remain relatively stable but with potential negative black swan events.
  • NZD to weaken due to government policy favouring a weaker currency.
  • NOK to strengthen considerably as oil remains strong, Norges Bank continues with its hawkish rhetoric and the Kroner moves to reflect Norway’s sound fundamentals.
  • Precious metals to perform well as the USD weakens, potentially breaking multi-year resistance zones.
  • US equities to see one final blow-off top before the start of a major correction lower.

Stelios Kontogoulas