Quaterly Market Outlook Q4’18

02 October 2018 : Trumponomics, the Federal Reserve, emerging markets turmoil, Oil prices, and Brexit negotiations were the biggest drivers of financial markets throughout the third quarter of 2018. These factors will continue to dominate the markets for the remaining quarter of the year, along with the upcoming U.S. mid-term elections as a potential shift in the balance of power could impact Trump’s ability to govern. 

U.S. equity markets outperformed the rest of the world so far this year, but many warning signals are starting to flash red. The U.S. economy is clearly in the late stage of the current economic cycle, but there are no signs of a recession yet. Valuations are overstretched compared to historic norms, and the Federal Reserve is expected to raise rates four times until the end of 2019. Given that U.S. equity markets seem to be priced for perfection, any negative surprises have the potential to end the longest bull market in history. 

In the currency markets, the Dollar’s exchange rate has attracted much attention throughout the past several months, especially against EM currencies where many of them fell to record or multi-year lows.

The Argentine Peso holds the title of the worst performing currency in 2018, having lost more than half its value since the beginning of the year. The Turkish Lira comes second, with more than a third of its value erased. While the South African Rand, Indian Rupee and Russian Ruble fell less significantly, they have still lost more than 10% so far.

Many of these economies face one or a combination of substantial current account deficits, external imbalances, shortages in FX reserves and political risks that led the currency to the selling wave. However, the Dollar also appreciated against its major counterparts, especially commodity currencies. With the Federal Reserve continuing to tighten policy faster than the rest of the world, the short-term outlook remains in favor of a stronger Dollar. This upward trend will likely start fading when other major central banks follow the path of the Fed, especially when factoring in that most currencies are undervalued in terms of purchase power parity. 

Sterling will likely be the most interesting currency to trade in the final quarter of 2018. While a no-deal Brexit could see the Pound falling 10%, the opposite case scenario has the potential to boost the currency by 5% or more. The Salzburg summit suggested that lots of work still needs to be done in order to achieve a withdrawal agreement. By late October or early November, the UK’s future relationship with the EU should become clear, and every headline related to the negotiations will be remain a trading opportunity. 

In the next quarter, keep a close eye on U.S. politics, trade developments, Brexit negotiations, and Oil prices. These factors will tell us all what we need for trading in Q4 2018. Here’s our outlook for the coming three months

By Hussein Sayed, Chief Market Strategist at FXTM

EURUSD: Investors not quite ready to pull trigger on rally

The longer-term outlook is that the Euro remains undervalued against the Dollar at its current level of around 1.15 at time of writing, and that these remain attractive valuations to consider purchasing the EU currency in the long run. However, investors want clear guidance from the European Central Bank (ECB) on when it will potentially raise EU interest rates to pull the trigger on a potential EURUSD rally. With the ECB more likely than not going to mirror memories of previous Federal Reserve Chair Janet Yellen and the Fed from 2015 by taking as much time as possible before finally raising interest rates, this is going to make investors hesitant to jump on potential EURUSD trade for a while yet. 

Analysts personally do not think the ECB and President Mario Draghi will be in a confident enough position to prepare investors for an eventual increase in EU interest rates until the end of the year, at the earliest. Expectations that the ECB will be lifting interest rates away from their record low levels by the second half of 2019 are premature as they stand. An increase in EU interest rates as we edge closer to the end of the current decade is by far the more likely scenario. This ultimately means that investors might not be prepared to consider adding material Euro purchasing positions into their portfolios until the end of the year, at least when it comes to optimism over ECB monetary policy. 

Downside risk for the Euro over the rise of populist parties in Europe and headlines over the financial health of Italy will remain, but these are also not new headlines and are something that investors will need to closely monitor instead. 

With it in mind that the ECB will be taking all the time it needs before providing confident signals that policymakers will be ready to raise interest rates before the end of 2019, investors will likely be looking for rounds of weakness in the USD for a jump in the Euro. This is exactly where matters get interesting for Euro bulls, because there are reasons to carry a negative view on the Greenback heading into Q4. 

U.S. interest rate expectations for at least the remainder of 2018 have been priced into the U.S. Dollar a long time ago. This weakens the monetary policy divergence that contributed to the EURUSD decline earlier this year. When you also consider the likelihood of the Trump Administration stepping up the narrative on the Greenback being too strong along with comments on U.S. monetary policy from Trump – you do have reasons to develop a negative view on the Greenback.

There are also the massive US mid-term elections in early November that will easily be seen as the biggest political risk event for financial markets in 2018, which supports the Euro outperforming expectations if the Greenback declines on election uncertainty. Investors do not appear to have yet factored in U.S. mid-term elections into valuations, and there might be a frantic frenzy of profit-taking on the Greenback around the November event.  

We have seen time and time again in the past how suddenly the Euro can rally to the upside when there is a round of investors unwinding USD positions. This is why we can’t rule out a potential EURUSD recovery before the end of the year.   

The current technical outlook in the Eurodollar suggests that the pair is facing a wall of technical resistance at 1.18, and the EURUSD will need to push above this level on at least a weekly basis for investors to price in a return to 1.20 in the Euro. 1.13/1.14 looks like a potential psychological bottom in the Eurodollar over the medium term and it would probably require intense concerns over the health of the financial system in Italy to push the Euro lower than this. 

Ultimately what investors might be more encouraged to consider is temptation to buy the Euro on dips. This is overall probably the most difficult outlook to provide for the final quarter, but if I were to pick a side then I would favour the longer-term view that the Euro should be appropriately valued much higher than its current levels.

GBPUSD: Pound can crash if hard-Brexit fears loom

It is no surprise the Brexit newsflow continues to dictate sudden fluctuations in the British Pound. Although what is surprising is that despite there being less than six months remaining before the United Kingdom is scheduled to leave the European Union with minimal confidence a Brexit deal is close, investors still refuse to price into expectations that there is a potential eventuality of a hard-Brexit. 

The British Pound trading close to 1.32 at time of writing provides memories of recent history where investors have been caught off-guard by political risk events. The historic outcome of the EU referendum springs to mind as an example of this and with the clock ticking fast until the deadline for a Brexit deal, investors should be more aware of potential downside risks to the Pound. 

At the moment, investors seem to be content with optimism that a Brexit agreement will eventually be struck. I think we just need to look at the events following the recent meeting in Salzburg and the defiant comments made by UK Prime Minister Theresa May after the summit to recognize that any optimism that a deal is close should be faint.  

Even if a breakthrough in Brexit negotiations is eventually struck, the upside potential in the British Pound is limited to around 5%. This is low in comparison to how fast the Pound could crash if a hard-Brexit is the eventual outcome. The Pound is at risk to crashing back down to the lower 1.20’s if investors become frightened over a hard-Brexit.  

There are no shortages of reasons for investors to hold negative views on the British Pound. The assertive comments from Theresa May following the failed Salzburg meeting that no a Brexit deal is better than a bad deal heavily highlights how strained UK and EU relations have become during the long-winded negotiations. The EU is obviously not wanting to provide UK officials with any favors to prevent other populist parties around Europe gaining encouragement from leniency shown towards the UK, suggesting that Theresa May will continue to struggle against EU officials.   

What is also not supporting Theresa May in her quest to secure a Brexit deal that is fair for those who voted to leave the EU two years ago is the ongoing and relentless speculation over her position remaining at threat to a potential leadership challenge. Reports over another potential UK election refuse to go away and investors need to see stability with leadership positions at a time where it is common knowledge that the UK will go through a period of uncertainty. The potential for a hostile Tory Party Conference for Theresa May in early October might provide encouragement for investors to take profit on Pound positions. 

All of the above doesn’t mean that there is no positive news out there for the Pound. The problem with current valuations is that investors are not positioned, or prepared at all for a potential hard-Brexit shock. Positive news for the Pound includes the continuation of UK economic data defying worrying forecasts of what the outcome for the UK economy would be following the EU referendum shock, and the probability that the Bank of England will remain ahead of the European Central Bank and Bank of Japan (when it comes to providing guidance on the possibility of higher interest rates. 

The technical outlook for the GBPUSD is somewhat conflicted by how suddenly the Pound can shift in direction due to sensitivity around Brexit newsflow.  

1.30 in the GBPUSD will continue to act as a strong psychological level for investors. Ambitious investors might continue to use the 1.30 level in the Pound to drive the currency towards 1.32/1.33. The pair would need to conclude above 1.33 on a monthly basis to instill confidence that the GBPUSD can rally above 1.35 on a Brexit agreement outcome. 

Otherwise, and while Brexit uncertainty remains, selling rallies in the British Pound will be tempting for investors. A technical close below 1.30 would signal the potential for further declines in the Cable.

By Jameel Ahmad, Global Head of Currency Strategy and Market Research at FXTM 

Reporting for EasyKobo on Tuesday , 02 Octber 2018 in Lagos, Nigeria