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Global Treasury

Rougher Economic Waters in 2018?

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May 02, 2017

Bigger financial and currency waves likely next year.

Fri Currency in Gears SmallThis year probably won’t all be smooth sailing in terms of the global economy, but many issues potentially impacting currency and financial markets are more likely to cause waves in 2018, and despite its recent dip expect the US dollar (USD) to continue to strengthen.

Those were among insights provided by bank experts who discussed their research with NeuGroup’s Treasurers’ Group of Thirty Large-Cap Edition (T30LC) earlier in April. Brexit may have been the primary story driving markets in 2016, this year it’s undoubtedly President Trump’s pro-growth agenda.

This year, the 10-year Treasury has mostly bobbled a bit under 2.5%, climbing from a trough closer to 1.5% through much of 2016. However, the rise has largely been fueled by expectations of tax reform, and if that fails, then expect rates to lose steam. If comprehensive tax reform happens, according to the bank, the 10-year Treasury is likely to peak this year at 3.5%, and if no reform becomes law it will head down to 1.8%, where it was on election day.

The bullishness in stock markets so far this year has probably been driven more by the improvement in global economic data than the potential for US tax reform, according to the bank. Global economic growth hasn’t taken off, per se, but compared to expectations it’s much improved. That’s reflected by the Purchasing Managers Index (PMI), which is above expectations and in the black across the major economies.

Last year’s global economic driver, Brexit, has turned out to be something of a nonstory, at least for now, and pound sterling (GBP) has weakened less than anticipated while United Kingdom growth has exceeded expectations. Many see data on the economic side deteriorating and going lower, and while it is bearish on GBP as a currency, it foresees the currency becoming more stable, and the Brexit story as more of a three to 10-year process.

Brexit negotiations are already underway and what happens in the next few months matters, but more important will be negotiations beginning after Germany’s September elections, so their impact will be unlikely until 2018.

Despite dipping this year, the USD is more likely to strengthen as the year progresses, according to bankers at the meeting. It’s not unusual for the dollar to take a pause and even retreat a bit before continuing upward. That’s because the USD is a outlier from a policy perspective, given the US is the only country in the G-10 that’s aiming to pursue fiscal easing and substantive monetary policy, with a deregulatory bias.

Although President Trump’s rhetoric regarding China was heated during the campaign and has prompted fears of a potential trade war, chances are that leaders of the world’s largest economy are more apt to play nice. Xi Jinping appears to be looking for a third term, currently not permitted under Chinese law, and there are major political events coming up in November and next March, so he will be incented to pursue a smooth growth story this year. Issues similar to 2015, when China failed to control capital outflows that prompted the renminbi to weaken and caused a ripple effect across markets, may be around the corner but probably not until 2018.

Another story for next year may be political fall out from elections in Europe. Bankers at the meeting expressed concern about Italy, which has an election later this year, perhaps early next year, as well as systemic risk stemming from its banking system and slow growth, and the potential for populist risk. However, that situation will take longer to play out and is more of a 2018 story.

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