While 2016 was the year the unlikely became real, currency investors enter 2017 no better equipped to tell the difference between reality and illusion.
Brexit and Trump made a mockery of assumptions, shredded investors’ best-laid plans and turned political risk analysts into the most in-demand advisers of the year.
The two big themes of 2016 will feel palpable during the first quarter of 2017. Donald Trump takes the oath of office to become US president on January 20. By March’s end, UK prime minister Theresa May will have sent to the EU the letter that triggers the UK’s formal divorce proceedings, and revealed some element of her negotiating hand.
All the same, neither of these “facts on the ground” will bring clarity to investors, even if their market behaviour in the tail-end of 2016 suggests they hope and expect otherwise.
A “dollar exuberance” broke out post-election, says Peter Rosenstreich of the internet-based bank, Swissquote. Trump promises of fiscal policy and tax reform had the “near-magical effects” of convincing investors that monetary policy would end smoothly, global growth enhanced and corporate profits boosted.
1. November 9: Donald Trump’s election victory spurs start of dollar rally
2. December 5: Supreme Court hearing into UK’s government’s Article 50 appeal adds to Brexit doubts, pushing sterling higher
3. December 7: China’s reserves drop a further $70bn as central bank struggles to halt sliding value of renminbi
4. December 14: Dollar rally sustained by Fed rate rise
This is giving the US consumer a false sense of wealth and wellbeing, he believes, arguing that US data merely reflects a temporary upswing in a large cyclical downturn.
“We remain sceptical that President Trump will accomplish anything close to the miracle growth rhetoric he has been supplying,” says Mr Rosenstreich.
Yet according to Nomura’s foreign exchange strategist Jordan Rochester, Mrs May’s Brexit plan is likely to be “very vague, full of hope, but lacking in any concrete details to safeguard the government’s negotiation tactics”.
For greater certainty, investors may well revert to what they have followed more closely in recent years — economic data and the utterances of central banks. This will be the case even if the limitations of monetary policy mean policymakers are supposedly passing responsibility for global growth to politicians.
Steven Saywell, BNP Paribas’s global head of foreign exchange strategy, says the dollar’s post-election rally of more than 11 per cent against the yen was built on Trump-fuelled expectations.
Contrast that with Janet Yellen, chair of the Federal Reserve, and her upbeat assessment of the US economy that accompanied last month’s rate rise.
“Inflation has picked up,” says Mr Saywell. “Even without Trump expectations, the dollar would be stronger.”
If the Fed is a better guide than Mr Trump for the dollar’s broad direction in 2017, what will determine the euro’s path — the European Central Bank or European elections?
The temptation for investors is to keep a close watch on the slew of 2017 European elections for further signs of the populist traits that secured victories for the Leave campaign in the UK referendum and Mr Trump in the US.
Yet as Derek Halpenny at MUFG points out, largely forgotten in the attention on Brexit and Trump were the actions of the ECB last month in increasing quantitative easing purchases.
These, he says, “brought about a revival in the divergence trade that will probably be the theme for the dollar, the euro and the yen in the first part of 2017”.
Mr Saywell agrees. “The euro hasn’t fallen as much against the dollar as the yen,” he says. “A lot will come down to the policy response of central banks.”
The ECB, he suspects, will taper monetary policy. While BNP Paribas forecasts the yen heading for ¥128 against the dollar, maybe even to ¥135, the bank expects the euro to drop to parity with the dollar but not much further.
“As the ECB exits QE, the market will rebound,” says Mr Saywell.
Still, the canny investor will doubtless keep up to date with all developments, political and economic, to chart the most trouble-free path through foreign exchange. As Simon Derrick at BNY Mellon says, 2017 has all the hallmarks of being a repeat of 1985 — loose fiscal policy, tax cuts, a hawkish Fed and a soaring dollar.
“It was the pressure of US corporates that was brought to bear on Congress and subsequently the Reagan White House that led to the abandonment of a strong dollar policy,” says Mr Derrick.
Could there be a similar political backlash in Trump’s US? “Absolutely,” Mr Derrick says.
This is by no means the only moment in 2017 when the realities of politics and economics will affect investment choices. The other, warns Mr Derrick, is China.
In November, the People’s Bank of China drained its reserves by $70bn and has consequently been reducing its holdings of US Treasuries to prevent the renminbi depreciating further. In the background stands Mr Trump, ready to repeat accusations that China has been deliberately weakening the renminbi for competitive gain.
“There is a reasonable chance China will rethink its currency policy,” says Mr Derrick. “It must be galling to be spending $70bn and at the same time to be called a currency manipulator. How that plays out next year will be fascinating.”