By Andrew Fately, 9th Gear Technologies
Yogi Berra is often attributed with saying “it is difficult to make predictions, especially about the future!” Whether the original author or not, Yogi’s sentiment holds true. There is a lot of disruption taking place across financial markets and the industry as a whole, some of which will yield measurable benefit to institutions and consumers alike.
Foreign Exchange
In early 2018 the prevailing wisdom was that the dollar’s rally had run its course and would be materially lower against most of its counterparts by year’s end. This was based on the structural issues facing the US, namely the expanding budget and current account deficits, coupled with the fact that the market had already priced in all the tightening by the Fed and robust global growth would force other central banks to tighten more aggressively than markets had priced.
Though this combination of events should have weakened the dollar, it appears the pundits were wrong. The Federal Reserve continued to tighten monetary policy and withdraw dollar liquidity more aggressively from markets throughout 2018, allowing the dollar to benefit all year.
So what about 2019? Not much has changed. As of Q4 2018, the market had yet to fully price in the rate trajectory that the Fed itself sees going forward. How does this impact the dollar against the euro, the British pound and the Chinese yuan?
EUR – European economic activity continues to lag that of the US, with growth on the Continent forecast by the IMF to be 1.9% in 2019 (vs. 2.5% in the US). While ECB President Mario Draghi continues to tout strong Eurozone growth, the numbers belie those statements, at least relative to the US. My estimate for the Euro is a further decline of between 8% and 10% to a year-end rate between 1.00 and 1.05.
GBP – The story in the British pound is far more straightforward, and largely binary. Brexit will be the driving factor in the pound’s value at the end of 2019. If the UK and EU manage to come to an agreement that avoids a “hard” Brexit,the pound will benefit relative to today’s levels. However, if no deal is agreed, then the pound will suffer a more ignominious outcome, with an immediate decline that could easily approach 10%. The UK will be diligent in finding other trade opportunities, notably with the US and Canada, and the pound will recoup a portion of those initial losses. By year’s end, look for pound Sterling to trade near 1.20.
CNY – The Chinese economy continues to increase its leverage while its growth trajectory slows, not a healthy situation. Additionally, the slowing growth in Europe, China’s second largest export market, is a concern, as is the trade fight with the US. When weighing the evidence, it seems clear the yuan is set to decline further in order to help alleviate some of China’s homegrown problems. While there is no reason to expect movement to be sharp, a gradual decline to 7.50 by year-end 2019 seems appropriate.
Interest Rates
10-year Treasury and German Bund yields – Bunds have every reason to rally in 2019 based on three factors: Eurozone growth is starting to fade; the populist coalition confronting EU dictates in Italy has all the earmarks of a crisis in waiting; and the probability of a hard Brexit will leave Germany one of the hardest hit given the UK’s prominence in its export hierarchy. These issues, not to mention the pressure on the Eurozone from refinancing the TLTRO-II’s will lead to a safe haven bid in Bunds and look for yields to be back at 0.00% come December.
Treasury yields, on the other hand, are a much different story. Based on the expected strong growth impulse in the US, the Fed’s continued shrinking of its balance sheet, removing the ‘price insensitive’ bid from the market, and the substantial increase in Treasury issuance that will come with the growing US federal budget deficits, all signs point to higher yields in the future. Nothing happens in a vacuum, however, and there are likely to be additional consequences of those three items, namely a substantial correction in the equity markets and a move to safe havens.
With this in mind, I expect Treasury yields to climb the first part of 2019 but by the year-end a significant equity market correction will have helped the 10-year yield back down to 2.75%.
Equity Markets
S&P 500 and STOXX 600 – It’s over, the bull market that is. Or at least it will be by the end of 2019 (and probably well before that). The valuation story has been the bears’ only hat to wear for the past three years, explaining that whether looking at the Shiller CAPE, the Buffet Index, or Tobin’s Q Ratio, all of them have been at levels only seen twice before, in 1929 just before Black Monday, and in 2000 just before the tech stock meltdown. In fact, all three of these are higher than levels just before the 2008 financial crisis. But valuations are not enough to drive markets by themselves. Other catalysts are needed as well, and in 2019 those catalysts are set to appear. The biggest are rising interest rates and reduced liquidity courtesy of the Fed’s monetary tightening.
2018 earnings were flattered by the corporate tax cut, which showed comparisons to 2017 in a very favorable light. In 2019, however, the comparison will be significantly more difficult, and earnings growth will be much lower - single digits at best. Another recession will be along again, and my fear is it will occur before 2019 is out.
WTI – Keeping with the theme that 2019 will be the year the recovery ends, oil will be similarly impacted. Competing issues in the oil market are on the supply side: whether Saudi Arabia, Russia and increased US production will be sufficient to offset the decline expected to be seen from Iran (because of renewed US sanctions) and Venezuela (as the infrastructure continues to crumble). If this remains the case a supply shortage will not be there to support the price of oil. On the demand side, if the forecast of slowing global growth and an incipient recession are correct, look for demand to slow substantially, tipping the balance and resulting in a price decline of between 15%-20%.
Bitcoin – Trading volumes have declined significantly since the peak in 2017, and interest in the entire cryptocurrency space is waning. Will we see this trend continue, or will Bitcoin serve as a sort of “digital gold” and be seen as a safe haven asset? The evidence points to the former. Despite the advent of Bitcoin futures markets, and the nascent Bitcoin derivatives markets, it remains a niche item, outside the mainstream for institutional trading. Also, if the economy does head into recession, it is more likely retail investors will be simply selling everything they own rather than looking for something to buck the trend. If Bitcoin loses the retail investor, then it has no one left. All this points to a further substantial decline in Bitcoin, as much as 30%, and I think I am being generous.
Andrew Fately is chief strategist at 9th Gear Technologies, the only B2B institutional marketplace that enables same day Foreign Exchange (FX) transactions with a peer to peer lending capability. Andrew has over 35 years of experience in capital markets across trading, sales and management roles at major Wall Street and U.K. financial institutions.