The US dollar has lost some of its momentum. A lot of the good news has been already incorporated into the exchange rate, and the slightest disappointment could lead to greater profit take-away. To secure substantial profits, it is, therefore, reasonable to carefully observe the side-lines. Further exchange rate developments will depend not only on the reports from the United States, but will be also affected by the prospective changes in the political landscape in Europe. We expect that the upcoming elections in several European countries will be the source of volatility for the currency markets in the coming year.
Rising inflation in Europe – the highest in three years – speaks in favour of a less expansive monetary policy on the part of the European Central Bank (ECB), which should induce interest rates to rise slightly and have at the same time a supporting impact on the exchange rates.
It was the weak euro and the markedly increased oil prices that fuelled the inflation. The oil prices had a particularly strong impact, mainly due to the base effect. It was only over a year ago that the price of oil was $ 28 per barrel, whilst currently a barrel is priced at US $ 54, i.e. 90 percent higher. For fixed income investments this scenario implies that one should act with caution when considering long-dated bonds. An absence of the ECB monthly bond purchases running in billions could have a negative impact on prices. Under the circumstances, should inflation return after so many years, one is advised not to be stuck for fifteen years with investments returning one percent!
The Chinese currency, yuan, presents quite a phenomenon. Following a slow (controlled), but steady appreciation up until the turn of the year 2013/2014, the yuan has lost about 15 percent against the US dollar within the last three years. The reason for this decline is the capital outflow from China and the associated flight into other currencies. The recent change in the White House is most likely to impact future exchange rate, as Trump will probably impose higher tariffs on imports from China. Considering Trump’s unpredictability, especially towards Mexico and China, one should, in general, stay vigilant as far as emerging market currencies are concerned. Worth noting still is that the new China’s National People’s Congress (3000-member parliament) is to be elected this autumn.
Looking at the British pound, here too, we expect a year of substantial fluctuations, with changes equally likely in either direction. Following UK currency’s last year depreciation by 20 percent already (see chart), we conjecture that adverse election results in France (Le Pen intention to abolish the euro) could divert the focus away from England and towards Europe, and thus, prompt a reverse reaction.
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