Of all the driver of currencies in the past few years, none have been as influential as shifts in central bank policy.
Think the US dollar ahead of interest rate policy normalisation from the US Federal Reserve in 2014 or, more recently, the Canadian dollar and euro ahead of shifts in policy announced by the Bank of Canada and European Central Bank last year.
While other factors have also played a part, the removal of emergency monetary policy settings helped explain the rally in those currencies in recent years.
To HSBC’s FX Strategy team, central banks will continue to be be the major driving force behind currency movements in 2018, but rather than helping the euro and Canadian dollar to rally further as was the case in 2017, the greatest currency gains this year are likely to be where central banks begin to normalise policy settings.
It suggested investors should look to “buy the exiteers” in a research note published over the weekend.
“The greatest gains in FX in 2018 are likely to be where central banks pivot to the exit,” it says.
“The ECB’s pivot happened in 2017 as did the Bank of Canada’s. Both the EUR and CAD rallied strongly in response. But these moves are complete and we believe the excitement for 2018 lies elsewhere.”
In HSBC’s opinion, that excitement will come from the likes of the Australian and New Zealand dollars with the bank looking for gains of around 8 to 10% against the US dollar in the year ahead.
On the Australian dollar, it says the Reserve Bank of Australia (RBA) is likely to deliver the first rate hike during June quarter given “above-trend GDP, and further tightening in the labour market and an associated pick-up in wages growth”.
“The RBA is unlikely to provide a great deal of forward guidance ahead of the move to hike so the rhetoric shift and the associated AUD rally may wait until Q2 as well,” it says.
“The RBA is likely to be comfortable with AUD strength given the trade-weighted AUD has not capitalised on the improving terms of trade in the last year. It is also at the cheap end of HSBC’s valuation range.”
HSBC is looking for the AUD/USD to close out the year at .8400, up from its current trading level of .7860.
And despite concerns about policy shifts from New Zealand’s labour-led coalition government, it also expects the Reserve Bank of New Zealand (RBNZ) to begin lifting interest rates in the second half of the year given the likelihood of a pickup in inflation.
“The new government provoked some NZD selling, but 2018 is likely to see the NZD-positive nature of their policies become more apparent, including the inflationary effects of fiscal stimulus, a higher minimum wage and restrictions on immigration,” HSBC says.
“Economic growth is forecast to accelerate to 3.0% in 2018 from 2.6% in 2017, supported by exports of tourism and dairy products, and reasonable growth in domestic demand.”
HSBC is forecasting the NZD/USD will finish the year at .7500, up from .7170 at present.
This chart from HSBC shows the percentage change it expects from major currency pairs this year compared to current market consensus.
Outside of the Antipodean currencies, it expects the Norwegian krone (NOK) and Swedish krona (SEK) will also have strong years, forecasting both to rally hard against both the euro and US dollar.
On NOK, it expects the Norges Bank to lift official interest rates in the June quarter, well ahead of market expectations currently centred around an increase by the middle of 2019.
“For a currency which looks undervalued on a historical REER [real effective exchange rate] basis and also on rate differentials, the pivot to the exit is likely to deliver a substantial boost to the currency,” it says.
HSBC says that Sweden’s Riksbank will also surprise market expectations, forecasting that it will lift interest rates not once but twice before the year is out.
“We expect the Riksbank to raise rates twice during 2018, first in June followed by December. The market is priced only for one, in November 2018,” the bank says.
“The SEK is undervalued by between 7% and 15% against the USD on our valuation range measure, and remains cheap when compared to where interest rate differentials would suggest it should be.”
As for an outlier currency call for the year ahead, it says it could well come from the Japanese yen.
“The slowing pace of bond buying means the Bank of Japan’s (BoJ) balance sheet is expanding less quickly and the knock-on perception is that it means less JPY is being pumped into the system,” it says, noting that “the tapering that got EUR bulls so energised in 2017 is already underway in Japan”.
“The BoJ’s pivot to the exit does not yet seem to be in sight given inflation remains so far from target. However, the focus on the “reversal rate” theory, which argues that a point can be reached where accommodative policy becomes restrictive because of its adverse impact on bank profitability and lending appetite, has opened the door to a possible increase in the yield target level from zero currently.
“As we have seen across G10, the currency responds not when the policy is actually changed, but when central banks begin to talk about change.”