2018 didn’t end on a happy note. Equity markets suffered a sharp correction, with US stocks facing their worst Christmas Eve trading session in history.
Interest rates plummeted as the economic outlook turned gloomy, amid falling global manufacturing output and escalating trade tensions between the US and China. The Fed, which up to that point had been continuously tightening monetary policy, had to reverse course – implicitly admitting it had made a policy mistake. Meanwhile, in the UK, Theresa May postponed the first ‘meaningful vote’ on her Brexit deal as it became clear it wouldn’t pass parliament. The possibility of a no-deal exit started to feel real.
Approaching the end of 2019, the outlook is more encouraging. The UK election resulted in a government with a significant majority. Boris Johnson’s Withdrawal Agreement is set to pass at the end of January. Assuming that the prime minister will also extend the transition deadline by mid-2020 to spare us another episode of UK-EU brinkmanship, a no-deal Brexit should be off the table.
As the UK’s Conservative party was celebrating its election victory, news broke that the US and China had agreed a “phase 1” trade deal. While the dispute between the two powers is far from settled, this temporary relief should support global trade and manufacturing output.
Against this backdrop, let’s look at what may be in store for currency and interest rate markets in 2020.
Interest rates - Hold the line
Starting with the UK, the Bank of England has been holding off on taking any monetary action in response to the Brexit limbo. Nevertheless, the mood swung towards a rate cut during recent meetings, largely due to the weaker global growth outlook. With the danger of no-deal receding, and the expectation (or hope) that pent up investment in the UK will buoy the economy, the case for rate cuts has become harder to make. At the same time, with inflation (1.5% as of October 2019) still below the 2% target, a near-term rate hike appears equally unlikely. Markets agree, and currently price the probability of a rate hike in 2020 at 0%.
Over in the US, the Fed is also expected to keep rates at current levels for the time being. That said, the US yield curve is still inverted, hinting at the possibility of a further cut before mid-2021. In any event, it looks as if a change in the trajectory of economic growth and inflation – for better or worse – would be required before we saw any movement in US monetary policy.
The same is true of the ECB. While Christine Lagarde should make for more entertaining press conferences than Mario Draghi, don’t expect a break with his policies. There are few prospects of a reversal in monetary policy in the Eurozone and some analysts even expect the ECB to ease further.
Currencies - Time for a weaker dollar?
Currency speculators must have had a blast trading the pound this year (provided they were on the right side of the moves!). For everyone else, it was a rough ride. GBPUSD hit a low of 1.2033 in August, only to rally back above the current level of 1.33, where it had been trading during the first quarter of 2019. Where could sterling go from here? In 2018, as Theresa May’s Withdrawal Agreement was taking shape, GBPUSD climbed to 1.43, helped by the weakness of the US Dollar that was a feature of Trump’s first year in office. That said, once no-deal is off the table for good, there seems to be plenty of room for further GBP strength. While consumers and UK importers rejoice, those who are long USD should take precautions. Needless to say, another cliff-edge situation at the end of the transition period next year would cause the pound to weaken sharply again. All told, GBP remains a volatile currency.
Source: Bloomberg, as of 16 December 2019
An end to the Brexit saga and easing of trade tensions should also be positive for the euro, but considering the economic fundamentals, the potential for a significant strengthening of the EUR versus the USD seems limited. It is worth noting that on a trade-weighted basis the dollar is still close to historic highs (see chart) – not surprising given its status as a ‘safe haven’ and its high yield relative to other major currencies. However, if the global growth and risk outlook improves over the course of 2020 with dollar interest rates remaining where they currently are, the fortunes for those who are long the greenback might reverse. It could well be time for a weaker dollar. The man in the White House would surely approve.
For more information, please contact Moritz Sterzinger, Director at Chatham, at firstname.lastname@example.org.