Last week was, on paper, one of the most exciting periods for the foreign exchange market in 2017. In reality, traders can look back on a few quiet trading days. This calm was mainly due to the deft manner in which central banks have anticipated policy changes far in advance. Wednesday's US interest rate hike was met with bored indifference on the financial markets.
American economy on the upturn
Over the last few months, Fed chairperson, Janet Yellen, used every opportunity to underline the fact that there would be an interest before the year was out. The Fed has also made every effort to anticipate any questions about the American economy's readiness for an interest rate hike. The prognosis for economic growth in 2018 has risen from 2,1% to 2,5%. Yellen reiterated that three more interest rate hikes are expected in the new year.
No surprises expected
A day later, the ECB decided to keep interest rates unchanged. This was also completely in line with expectations. A rate hike will only become relevant after the stimulation programme comes to an end. This programme will run until at least the end of September next year. The Bank of England has also left interest rates as is. All nine members of the bank supported this decision. This degree of consensus shows that this was not an unaccepted move.
Greenlight given
Traders have, with regard to interest rates, seldom been this sure of where they stand. This has become evident in how exchange rates fluctuated, without any major changes, through the past year. Even the 'Brexit Summit' held by EU leaders in Brussels had no influence on this. This past Friday, the Brits and the EU came to a consensus with regard to separation conditions. Now, talks about future relations can get underway. There was already clarity, even before the summit, of what the potential points of contention were. These include the level of Britain's contribution to Brexit, the rights of EU citizens in Great Britain, and the relationship between Ireland and Northern Ireland. Again, no surprises for the markets.
Traders have, with regard to interest rates, seldom been this sure of where they stand. This has become evident in how exchange rates fluctuated, without any major changes, through the past year. Even the 'Brexit Summit' held by EU leaders in Brussels had no influence on this. This past Friday, the Brits and the EU came to a consensus with regard to separation conditions. Now, talks about future relations can get underway. There was already clarity, even before the summit, of what the potential points of contention were. These include the level of Britain's contribution to Brexit, the rights of EU citizens in Great Britain, and the relationship between Ireland and Northern Ireland. Again, no surprises for the markets.
Calm before the storm
Do not be fooled by the current quiet foreign exchange markets. Everything is pointing to 2018 being a fairly tumultuous year for foreign exchange markets. Although a new round of Brexit talks has been planned, the outcome of these talks is by no means certain. On 29 March 2019, the United Kingdom will leave the EU. British Prime Minister, Theresa May, is, however, not very forthcoming about how she sees future relations with the EU. Her position in the British Parliament is shaky. There are various possible scenarios, varying from absolutely no agreement to one of good cooperation, with a transition period. The danger of a 'hard' Brexit or even leaving the EU with no agreement in place would have serious repercussions. These scenarios would have a renewed negative effect in the British Pound.
Do not be fooled by the current quiet foreign exchange markets. Everything is pointing to 2018 being a fairly tumultuous year for foreign exchange markets. Although a new round of Brexit talks has been planned, the outcome of these talks is by no means certain. On 29 March 2019, the United Kingdom will leave the EU. British Prime Minister, Theresa May, is, however, not very forthcoming about how she sees future relations with the EU. Her position in the British Parliament is shaky. There are various possible scenarios, varying from absolutely no agreement to one of good cooperation, with a transition period. The danger of a 'hard' Brexit or even leaving the EU with no agreement in place would have serious repercussions. These scenarios would have a renewed negative effect in the British Pound.
Nexit, Frexit, ExItaly
There is a major difference in the financial markets compared to twelve months ago. There is, besides the uncertainty surrounding Brexit, much less focus on European politics. In the run-up to 2017, some groups were still very concerned about elections in the Netherlands and France. It was feared that, just as in Great Britain, a party that would want to hold a referendum on EU membership, might win those elections. This decreased political risk was a major contributing factor to the rise in the value of the Euro over the past year.
There is a major difference in the financial markets compared to twelve months ago. There is, besides the uncertainty surrounding Brexit, much less focus on European politics. In the run-up to 2017, some groups were still very concerned about elections in the Netherlands and France. It was feared that, just as in Great Britain, a party that would want to hold a referendum on EU membership, might win those elections. This decreased political risk was a major contributing factor to the rise in the value of the Euro over the past year.
All good news?
Many investment banks predict that this upward swing will continue in 2018 thanks to favourable economic development in Europe. This makes the US interest rate hike, and the uncertainty surrounding Italian elections that are to be held early in the year less of a threat. If the Federal Reserve keeps its word, by the end of the year, the US interest rate will be more than 2% higher than that in Europe. In addition, the arrival of the new Fed chairman, Jerome Powell in February 2018, will also shake things up. After the current quiet period, foreign exchange markets can look forward to a turbulent 2018.
Laurens Maartens (laurens.maartens@nbwm.nl) is foreign exchange expert at Nederlandsche Betaal & Wisselmaatschappij (www.nbwm.nl). He started his career at the Swiss bank, UBS, in 1998. Since then he has worked at various local and international groups. He gives his comments on current currency developments on websites, in newspapers, and on the radio. He also gives lectures and training about currency management to businesses. He urges participants to choose mainly simple and inexpensive currency products. This article is his personal opinion. The information contained herein is not meant as professional investment advice or as a recommendation to make specific investments via Nederlandsche Betaal & Wisselmaatschappij NV.