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Major U.S. financial institutions expect choppier global Forex market

2018-12-12 09:47

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Leading U.S. financial institutions, including Bank of America (BofA) Merrill Lynch and UBS, projected volatility in the dynamic global foreign exchange (Forex) market in the year ahead, casting a bearish outlook on the U.S. dollar.

Both BofA Merrill Lynch and UBS expected global growth to slow to 3.6 percent in 2019, down from 3.8 percent this year, as most of the major economies are forecast to see weaker growth next year. Likewise, the U.S. economic growth, weighed by ebbing fiscal stimulus and higher interest rates, will also likely to lose steam.

Lingering global trade tensions and political uncertainties in Europe, mainly Brexit chaos and Italy's budget controversies, have also thrust the global Forex market into turmoil, according to analysts.


"The decline in global growth will mean a weaker tailwind for global markets, which could begin to anticipate an end of the economic cycle as 2019 progresses," said UBS Global Wealth Management (GWM) in its forecast report titled Year Ahead 2019.

In particular, the U.S. dollar is likely to depreciate over time and lose to some extent its advantage against the world's other major currencies next year, as the greenback will bear downside pressure both domestically and geopolitically.

The U.S. economy is expected to grow by 2.7 percent in 2019 and 1.9 percent in 2020, down from an estimated 2.9 percent growth in 2018, as fiscal stimulus may fade in the second half of 2019, revealing an economy growing near potential, according to researchers of BofA Merrill Lynch.

"Most of the dollar gains appear to be in the past. A weaker dollar is expected in 2019, against a stronger euro and Japanese yen," said the researchers.

The top U.S. financial institution believed that there would appear "an unprecedented level of global monetary policy divergence," as the U.S. Federal Reserve continues to hike interest rates and other major central banks don't, as a result of which will set the dollar on a downward track.

Ralph Axel, senior U.S. rates strategist of BofA Merrill Lynch, told Xinhua that the Fed is going to hike throughout 2019 based on a GDP call of 2.3 percent for the fourth quarter of 2018.

"So the base case scenario is that growth is good, inflation keeps going up, job market continues to strengthen and the Fed takes its opportunity along the way to a very, very cautious and data dependent hiking-cycle throughout the year," Axel said. "When fed tightens, it's going to be difficult to orchestrate a very smooth slowdown."

UBS researchers also shared similar perspectives on a weaker dollar. Mark Haefele, chief investment officer of UBS GWM, told Xinhua that other currencies were undervalued, as the demand for the U.S. dollar as a safe-haven currency increased due to persistent market volatility.

However, he believed that potential changes in U.S. interest rates will weigh down the greenback in 2019. "A lot of interest rates differentials (between Fed and other central banks), the higher yields (of short-dated Treasury bonds) in the United States, are priced in now. So over time we will expect the overvalued dollar will fall," Haefele explained.

Aside from the financial risks, political gridlock in Washington also posed potentially "the greatest risk" to the greenback in 2019, according to BofA Merrill Lynch Global Research.

The U.S. mid-term elections in November have produced a divided congress with Republicans keeping hold of the Senate and Democrats clawing back the control of the House of Representatives.

The top U.S. financial institution cautioned that the last time Washington went into a gridlock, political brinksmanship brought the country to the verge of default in 2011, as the debt ceiling crisis that year brought on extreme volatility in rates and the dollar.
Debt ceiling, a legislative limit on the amount of the U.S. national debt, limits how much money the federal government can borrow from the U.S. Treasury.

"Trump will need the support of the Democrat-controlled House to raise the debt ceiling in early summer. The key is what the Democrats will demand in return,"said BofA Merrill Lynch Global Research.

Janet Yellen, former Chair of the Board of Governors of the Federal Reserve System, indicated four factors that worried her about the U.S. economy, i.e. leverage lending, rising assets prices, high commercial real estate prices and low rates of return.

"I worried about leverage lending, the kind of lending to highly indebted corporations. Corporate indebtedness is now quite high. I think it's a danger that if there is something else that causes the (economic) downturn, that high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector," she said during an event held by the City University of New York on Monday.
She also mentioned that there remain "gigantic holes" and regulatory pushback in the U.S. financial system after the devastating 2008 financial crisis, leaving an agenda of unfinished work for the country in the post-crisis era.

"We're seeing a lot of pushback against regulation after eight years of writing thousands of pages of regulation...We're entering again really only a decade after the crisis in era when there's a huge focus on deregulation," she said. "There was a big to-do list of things that still needed to be worked on."


The ongoing global trade tensions have exacerbated risk aversion of jittery investors, who also have to prepare for potential geopolitical implications in both the United States and Europe.

"The strength of the dollar will depend heavily on evolution of the trade relationship between China and the U.S., which in the short term may mean selling the dollar against a currency insulated from trade war rhetoric, such as the British pound and Swiss franc," said BofA Merrill Lynch in its report.

The deepening political uncertainty over Brexit and Italy's budget plan has sent shocks rippling through the European market, sinking the global Forex market into deeper volatility.

Sterling tumbled to a 21-month low, down more than 7 percent since the start of the year, after British Prime Minister Theresa May postponed on Monday a parliamentary vote on her planned Brexit deal previously scheduled for Tuesday.

The abrupt moves fanned panic over deepening market instability in Europe, as speculations built up that a disorderly no-deal Brexit, another referendum on Britain's EU membership, or a last-minute renegotiation of May's deal with Brussels could come out of blue in the future.

Italy has stuck into in a standoff with the European Union over its proposed 2019 budget plan, rejected by the European Commission last month. Rome's budget deficit figure of 2.4 percent of its GDP, an alarming surge of its previous deficit goal of 0.8 percent of GDP, has rattled European capital markets.

Yet Rome defied the commission's request to revise its high-spending budget plan, risking financial sanctions in the stalemate with Brussels.

Yellen pointed out that Europe has been suffering from some of the same problems that the United States had suffered from of rising inequality in the disappearance of decent jobs for less skilled people, and the European financial system is not as strong as that of America.

"There were problems in the design of the euro area that still need to be addressed. There are problems with its functioning countries like Italy with very high debt-to-GDP ratios," she said.

Adding to market uncertainty, global monetary policy is expected to become "less friendly" in 2019, as further divergence will likely continue in monetary policy between the Fed and other major central banks, according to BofA Merrill Lynch.

UBS also believed policy normalization of central banks in the European Union, Switzerland and Japan would put a damper on the greenback's comparative edge, as there will appear changing interest rate differential between the greenback and world's other major currencies.

"The European Central Bank (ECB) will only be starting to normalize interest rates, which will cause the differentials to shrink and the dollar's advantage to recede," USB stated in its report.

Similarly, the Swiss National Bank, UBS noted, will also raise its target rate after a first rate hike by the ECB in 2019 amid global uncertainty, which will raise the Swiss franc against the dollar.

Elsewhere in Asia, the Bank of Japan has been considering pulling back its monetary stimulus as Japan's inflation is getting back to normal, which will strengthen the yen.

Another boost to the yen is the projected rising Japanese 10-year government bond yields in 2019, which will also help narrow the gap between the yen and the greenback, according to UBS.
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