Societe Generale Forecast Update: Struggling to See Where the Good News Will Come from for GBP

© Mohamed Yahya, Reproduced under CC licensing

- USD and EUR to reverse trend next year says Societe Generale.

- But it's difficult to see where 'good news' comes from for the GBP.

- China's CNY is a wild card playing increasingly important role in FX.

The U.S. Dollar will reverse course and fall in 2019 while Europe's single currency rises from its current lows, according to the latest forecasts from Societe Generale, although the extent of these moves will depend greatly on what happens to China's currency. 

China's Renmimbi has gained an increasingly prominent voice in the global currency market, one likely to grow louder next year, although the state's tight control of the unit and its vague guidance around exchange rate policy mean a lot about the 2019 outlook is still uncertain. 

"The Chinese yuan has the biggest share of the ECB and Federal Reserve’s EUR and USD trade-weighted baskets respectively, and after years of an appreciating trend (in real and nominal terms), it has been falling," says Kit Juckes, chief FX strategist, in Societe Generale's year-ahead outlook. 

Juckes says the 2018 fall in China's currency means the Euro is not quite as cheap as it looks and the U.S. Dollar is certainly expensive on a fundamental basis. A strong positive correlation between the U.S. Dollar and Chinese currency, as well as a negative correlation between the Euro and Renmimbi, makes Chinese FX policy key to the 2019 outlook. 

This means the next steps in the so-called trade war between the U.S. and China will also be key to the outlook for those three currencies as well as the rest of the entire foreign exchange market. 

But Chinese exchange rate policy is not the only thing that will matter in 2019, as Juckes says investors will also increasingly take their cues from currency valuations in general as well as relative rates of economic growth.

The last two years serve as testament to powerful effect that growth differentials can have on exchange rates.

After all, the market has been dominated this year by a U.S. Dollar that emerged resurgent from a first-quarter decline after it became clear the U.S. economy was gathering pace just as growth elsewhere had begun to slow. 

That supported the Dollar by enabling the Federal Reserve to raise its interest rate repeatedly as other central banks moved only slowly, if at all. 

However, markets have become increasingly attuned in recent weeks to the possibility that growth could soon slow and force the Federal Reserve to at least pause its interest rate hiking cycle.

Below is a selection of views from Juckes and the Societe Generale team outlining what all of this could mean for individual exchange rates next year. 

The Dollar index was quoted 0.09% higher at 96.72 Monday and is now up 4.8% for the 2018 year overall. It is up 8% since the beginning of April.

The Pound was -0.75% lower at 1.2617 against the Dollar but is down -6.5% in 2018, while the Pound-to-Euro rate was down -1.02% at 1.1057.

The EUR/USD rate was up 0.31% at 1.1414 but is down -4.85% this year, and the EUR/GBP rate was 1.28% higher at 0.9043 and has risen 2.22% in 2018.

Above: Societe Generale exchange rate forecasts.

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Pound Sterling 

"We’re struggling to see where any ‘good news’ could come from, unless parliamentary paralysis forces a second referendum (in which case EUR/GBP is likely to return to a 0.75-0.80 range). More likely, EUR/GBP will trade towards the top end of the 0.82-0.94 range it’s been in since the vote, while GBP/USD continues to track EUR/USD closely."

"The correlation between GBP/USD and EUR/USD has increased since the vote. This is in part because, from cheap valautons, sterling cannot fall much relative to the euro but lacks a reason to bounce, and also because while brexit is worse for the UK than for the eurozone, it is bad on both sides of the Channel."

"A no-deal Brexit, for example, would be an anchor on EUR/USD as well as on GBP/USD. But it follows that if there’s a lot of bad news already priced into the current EUR/USD level, GBP/USD also has upside bias next year."

U.S. Dollar 

"The widening trend in yield differentials – both real and nominal – between the US and its major competitors, paused in 2017 but has resumed with a vengeance."

"The increasing cost of money has hit some emerging market currencies hard (the Argentinean peso and Turkish lira have been the hardest hit this year, but the Brazilian real, South African rand and Russian ruble have all fallen by over 10% in 2018), and all the G10 currencies have lost ground. The yen and Swiss franc have been the most resilient, highlighting the extent to which the US dollar has become the Bellwether of global risk sentiment."

"This impressive performance however, is unlikely to be maintained in 2019 as the Federal reserve reaches the peak of the rate cycle, as US growth starts to lose momentum and relative growth expectations deteriorate, and as the focus shifts back to the US’ twin current account and budget deficits."

Euro

"Two things have gone badly wrong for the euro in 2018...Firstly, Bund yields, which rose by 45bp in the first few months of the year, have since fallen back on underwhelming economic data. They are currently a few basis points below where they were at the start of the year, whereas US Treasury yields are 65bp higher. The second thing that thas visibly gone wrong is the BTP/Bund spread."

"Both bond and currency markets are pricing in the negative economic effects of the threat to the euro project, and a risk premium in case the worst happens. Remove those and the currency will recover."

"The big dangers in the coming months are a break higher in USD/CNY, and the US impose auto tariffs. These are real enough threats, along with the ongoing Brexit uncertainty and spat over the Italian budget, to make diving in to buy the euro at the start of 2019 a risky idea."

"Given political and economic headwinds that just won’t go away, euro strength is likely to be no more than part of the general weaker dollar trend."

Australian Dollar 

"The Australian dollar has been among the chief casualties of escalating USChina trade tensions and related China growth fears. The combination of the external risks and the US dollar rally this year has dragged down AUD/USD significantly."

"Despite the positive economic outlook, there are countervailing trends that should keep the RBA comfortably on the sidelines. Wage pressures have remained moderate. The housing market has turned lower, especially in Sydney and Melbourne, amid tighter lending standards."

"On the other hand, Australian terms of trade have been firm this year, and iron ore prices have rebounded convincingly from their summer lows. In light of our view that the USD is expected to weaken gradually against the EUR and JPY, we anticipate that the cycle low in AUD/USD was seen in early 2016 and is now behind us."

New Zealand Dollar 

"The New Zealand economy is puttering along. The housing market in Auckland has cooled markedly on the back of restrictions on foreign buyers and tighter lending standards, but there has been no crash. Net migration flows have continued to decline. Although the unemployment rate has fallen steadily, wage pressures remain moderate."

"New Zealand’s terms of trade have hovered near the record high level reached in December 2018, but this is one of the few fundamental factors supporting the Kiwi dollar. The RBNZ’s dovish policy stance has seen the NZD face growing headwinds from interest rate differentials."

"We expect the Kiwi dollar to be a laggard in 1H19 due to the lack of a compelling growth story...The risk of a continued worsening of US-China trade relations implies downside risk to our NZD/USD forecast, but upside risk for the AUD/NZD cross."

Canadian Dollar

"Despite a soft 2H, the Canadian dollar has resisted USD strength across the board well...We expect this resilience to morph into genuine strength in 2019, driving the USD/CAD gradually towards 1.25."

"The BoC welcomed the negotiated deal in rising rates to 1.75% in October. The hike was widely expected, but the central bank also dropped the “gradual approach” reference in its statement, suggesting that the normalisation pace is likely to gain momentum in 2019, towards the 2.5-3.5% neutral rate."

"Our commodity strategists recently upgraded their oil forecasts, due to bigger sanction losses from Iran, and demand growth that should remain healthy. This should lead to robust Brent prices in 2019 that we expect to average at $75. With oil exports remaining a key engine of the Canadian economy, solid oil prices are going to support the CAD."

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