FW: RHB FIC Rates & FX Market 2018 Annual Outlook - 13/12/17

 

 

 

 

13 December 2017

 

Rates & FX Markets

2018 Annual Outlook

 

Ten Years Later, A Cautious Optimism Prevails

Highlights

Risks and uncertainties are words that defined our 2017 outlook. Turning to 2018, some of these risks are likely to linger alongside the emergence of new factors that we have summarised in this publication which represents our views for the rates and currency markets in 2018.

As we expected, political developments have been key in particular for developed markets, creating both upside risk in Europe and downside risks in the US. Despite being acknowledged by investors, a political risk reversal is unlikely to emerge in the US while populism in Europe could still pose a threat to Italy, and perhaps in Germany (a possibility at the time of writing).

The supportive global growth backdrop led to an adjustment in expectations of monetary policies and rhetoric changes for most central banks. However, the risks of an export normalisation, more excessive than anticipated, could expected to dampen growth outlook, with little room to manoeuvre in terms of monetary policies.

The future of those monetary policies is even more dependent on inflation. The economic-recovery-less-inflation scenario is playing out as we expected and contrary to central banks' explanations we are sceptical on increasing price pressures as wage growth stagnates, further threatened by a technological/digital revolution exponentially progressing. The central banks' clear communication does limit the risks of financial market disruptions but a too aggressive tightening Fed could lead to a market correction when assets are at historically elevated levels.

The EM story has turned from a yield hunting trade to a fundamental one. While, the growth momentum in advanced economies supported emerging countries along the way, Asian stellar performances can also be attributed to the Chinese economic rebound and improving fundamentals in the region; EM resisted to the Fed's hikes and stronger currencies did not harm exports. Idiosyncratic risks do exist with the Chinese deleveraging reforms and risks of growth normalisation.

However, geopolitics will continue to play a crucial role on financial markets. The situation in the Korean Peninsula impacted local and global markets. Now, the escalating tensions in the Arabian/Persian Gulf and Middle East, as we already highlighted in June, pose a major threat to the world stability (and commodity prices) given the complex diplomatic and economic relations between regional countries and the US, Russia and China.

Lastly, the outlook for sovereign creditworthiness in 2018 appears stable. Despite high debt constraining fiscal reforms, credit upgrades and stable/positive outlooks increased in 2017. Now, the highest risk seems to lie with the US, a country not committing to fiscal discipline in time of economic expansion.

 

Rate markets: we maintain our expectations of a flatter US curve in 2018 as the Fed hikes in a data dependent / discretionary approach while structural factors should keep longer yields anchored. Elsewhere, central banks' decisions will be key especially for those which have not joined the hawkish chorus.

Currency markets: expect protracted USD weakness as longer term structural drivers materialise alongside the confirmation of those already in play. The Euro and Asian currencies could benefit the most given the positive narratives.

 

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