2016 has set the foundations for 2017 in a way that keeps many of us in suspense. Fluctuating exchange rates will play an important role for businesses that trade, manufacture or source materials internationally.
What’s happening at home
There are four main factors likely to impact on the AUD in 2017:
1. A slight change in policy direction for the RBA looks likely to result in less interest rate cuts, which could boost the AUD. However, these policy changes have also resulted in hikes, which contributed to a slight weakening of the AUD early in January, and may continue to do so, particularly in the short term.
2. If iron ore prices continue to forge higher this year, the Australian dollar should continue to remain buoyant for its strength.
3. It seems likely that President Trump’s reign could have a negative impact on the AUD, due to his US protectionist political stance. If an American-Chinese trade war results in a slowdown in the Chinese economy then, as Australia’s main trading partner, our dollar will be negatively affected.
However, there are some views that pressure on Chinese trade with America could cause China to ramp up investment in other areas of its economy. With infrastructure being a high priority for the country, it could drive the Aussie higher.
4. AUD weakness could also come from an increase in US interest rates and an increasingly strong USD.
Trump’s aggressive policies could force the Federal Reserve to raise interest rates in a more regular fashion than anticipated, which will erode the Aussie’s yield advantage. Trump’s policies are also likely to negatively affect risk appetite, which will drive risk currencies, like the Aussie, significantly lower.
What’s happening in the countries we trade with
Markets have embraced President Trump as a catalyst for US growth. The USD has seen some remarkable strength since Trump was elected due to his promise of mass infrastructure spending and an optimistic run in the bond market. The USD has also been boosted by the prospect of three hikes by the Federal Reserve this year and an increasingly impressive job market.
A tougher regulatory environment will be felt keenly in emerging markets, courtesy of Trump’s election, since his protectionist policies are a threat to trade. He has promised to take a combative stance in trading negotiations in order to boost US manufacturing and the US economy.
The US’ neighbour Mexico will likely face more pressure than anywhere else. The USD/MXN cross has already become a vital indicator of Trump’s policies. This has been shown through his executive orders, which saw the peso slip against the dollar.
Trump has previously labelled China as a currency manipulator and he has the ability to implement policies that would negatively impact trade from the country unilaterally.
The extent to which he commits or applies promises made on the campaign trail over his administration remains to be seen, but it could be that too tough a policy would damage both the US and Chinese economies.
It is also likely that a combative US and strong US dollar will place strain on places like Singapore and Korea, which rely on US funding and a free and easy trade environment, or Indonesia and Malaysia given the volatility in their currencies of late.
Political risks in Europe are front of mind for investors looking at EUR/USD and the single currency on a wider basis:
1. Former Italian PM Matteo Renzi’s loss leaves another political air pocket at the top of a European government. Italy was and remains among the Eurozone countries that were pressured on their debt piles through the global financial crisis, and the situation has not improved despite low interest rates and an accommodating Central Bank.
2. People are anticipating that France and the Netherlands may have a successful populist win. Geert Wilders and Marine Le Pen are the leaders of the PVV party in the Netherlands and the Front National in France respectively, and are both in the lead in the latest opinion polls.
Within the Brexit campaign, vote and aftermath, focus on the popularity of the European Union as a whole was at the forefront of the European political conversation.
Wilders and Le Pen have both commented positively on the Brexit phenomenon and will use lessons learnt from the campaigns to drive engagement and popularity in their respective countries.
It’s possible markets are overstating the longer-term political risk within Europe, but in the short term there is some weakness in the Euro, especially against the USD.
Issues of growth and inflation (or lack thereof) in the Eurozone will also provide persistent pressure moving forward and any moves by the European Central Bank to create either will give investors another reason to sell.
Inflation will likely be the main economic indicator of damage from Brexit and it’s expected this will be felt throughout 2017. It’s anticipated this will manifest in weak growth and stale investing.
The retail sector in the UK will likely see higher prices in the early part of the year, which is unlikely to be well received by consumers.
This puts the industry at risk of low-cost operators and discounters swooping in. If they don’t, the UK could see a rise in unemployment. Higher unemployment could, in fact, occur regardless of outcomes in the retail sector.
Should the negotiations between the UK and EU run smoothly, sterling has the potential to recover some of its losses against the USD. This is by no means a certainty though, particularly due to recent ‘hard Brexit’ talk by UK Prime Minister Theresa May.
The complexity of the situation means that the Bank of England is unlikely to take significant action in guiding or reviving the GBP regardless of the way the tide turns. What could have an impact on the strength of the GBP is its reputation as a haven against the Euro, as the EU works through political uncertainty.
While currency rates are uncertain by nature, 2017 is set to demonstrate that to a high degree. It’s important to be prepared for an increase in fluctuations and, as is always the case, ensure that the appropriate strategy is implemented for your business and personal currency transactions.
Alexander Cook is a senior currency specialist at World First.
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