All major currencies will have substantial risk elements during 2019. To some extent, this is always the case of course, but there are additional risks this year given the element of complacency surrounding the global economic outlook and extremely high debt levels.
Consensus expectations are for solid growth in major economies with central banks able to increase interest rates at a very steady pace which does not jeopardise growth conditions or undermine financial stability.
Asset prices reflect this confidence with major currencies held in relatively narrow ranges while many equity markets, including Wall Street indices, have pushed to record highs.
A very important risk factor for the year ahead is that this confidence proves to be misplaced and that expectations have to be adjusted rapidly. If equity markets come under sustained pressure, risk appetite will deteriorate sharply which will have important implications for currency markets.
There would be renewed demand for defensive plays such as the Japanese yen and Swiss franc. Currencies of countries running substantial budget and current account deficits would be especially vulnerable.
Domestic and geopolitical factors could also have a substantial impact with potential risks across the US, Euro-zone and Asia:
1. US President Trump is impeached.
2. Italian elections in March trigger a fresh Euro-zone crisis.
3. The Spanish Catalonia situation deteriorates sharply.
4. Conflict breaks out surrounding North Korea.
On a sustained basis, the following currencies hold the largest overall risk elements during the year.
Political developments will be a very important Sterling risk factor during 2019 as Brexit negotiations resume.
According to the current timetable, Brexit is scheduled to take place in March 2019 and the framework deal will need to be in place by late 2018 at the latest in order for UK and EU governments to approve the deal.
Tensions will, therefore, gradually increase during the year and there will be substantial risks during the third and fourth quarters, especially if no deal is in place.
In broad terms, Sterling will tend to gain ground if an acceptable deal and transition arrangement looks to be assured. In contrast, the UK currency will decline sharply if there are increased fears surrounding a disorderly exit. In this context, there is a high risk that sentiment will fluctuate sharply.
The UK economy also has important underlying vulnerabilities with substantial current account and budget deficits. These weaknesses will tend to amplify any loss of confidence. Sterling volatilities have dipped to 3-year lows but could increase rapidly.
The Canadian dollar will face important risks during 2018 with a notable focus on the housing sector and household debt.
The period of very low domestic interest rates has encouraged a housing-sector boom and a sharp increase in debt levels. For the third quarter of 2017, household debt increased to C$2.11 trillion and the household debt to income ratio increased to a record 171%. This has increased from below 140% ahead of the 2007 financial crash and less than 100% 20 years ago.
The Bank of Canada increased interest rates twice in the second half of 2017 as is expecting to raise rates further in 2018. The Canadian dollar would tend to strengthen in an immediate reaction to higher interest rates.
House prices, however, have fallen for the last three months and the Canadian economy will be very vulnerable if there is a sustained decline. Weaker house prices would increase debt pressures and risk pushing the economy into recession, especially if there are stresses within the banking sector.
These risks will intensify if the US decides to break up the free-trade area between the US, Canada and Mexico (NAFTA).
The Chinese economy will inevitably be an important focus during the year even though market attention has faded slightly.
Chinese total debt levels have continued to increase to a record high of 294% of GDP. The People’s Bank of China (PBOC) has nudged interest rates higher and has been successful in managing monetary policy with the yuan broadly stable.
Given extremely high debt levels, however, there is still an important risk that the economy will come under sustained pressure and face a sharp slowdown as bad debts increase and the banking sector come under sustained stress.
These risks will intensify sharply if there is a sharp increase in US interest rates with the PBOC either forced to raise interest rates or allow the yuan to weaken.
Saudi Arabian riyal
Concerns surrounding the Saudi Arabian Riyal eased during the second half of 2017. Domestic budget pressures have been alleviated by a rally in oil prices and the weaker US currency has also lessened potential selling pressure on the currency even though interest rates have been pushed higher.
There are still very important domestic risks given underlying pressure on the budget. Political tensions also increased sharply after the purge of opposition voices late in 2017 while defence spending has been pushed higher by protracted involvement in Yemen’s civil war.
Relations with Iran also remain under serious pressure. If oil prices decline and US interest rates continue to move higher, there will be the risk of severe pressure on the riyal.
Given that Saudi Arabia runs a fixed currency, any peg break would risk a very sharp devaluation and also undermine regional currencies.
Hong Kong Dollar
If the riyal peg did break, there would be the risk of sustained selling pressure on the Hong Kong dollar with a surge in speculation that other global pegs would be broken. The Hong Kong dollar will also come under sustained pressure if there is a sharp decline in the Chinese yuan and higher US interest rates.
Officially, the Venezuelan bolivar trades at a fixed rate of 10.0 against the dollar. On the black market, however, the currency trades around 137,000 to the US currency. For all practical purposes, the bolivar no longer has any value as a currency with domestic transactions increasingly demanded in dollars, barter or even in cryptocurrencies.
Although oil prices have strengthened, the economy will remain in crisis mode unless there is a shift in economic policies or lifting of US-imposed economic sanctions. The Venezuela situation illustrates how economic mismanagement can trigger a currency collapse.