A Look Back at Late 2018 and a Look Ahead to Early 2019

We wanted to alert our readers to recent market events that might have been overlooked due to the holidays. Furthermore, we offer some brief thoughts on 2019, many of which will be fleshed out further in our upcoming FX Quarterly for Q1 2019.

The dollar had a stellar 2018 vs. the majors. For the year, only JPY (3%) gained against the dollar. CHF was next best at -1%, while the worst performers were AUD (-10%), CAD (-8%), and SEK (-7.5%).

Looking at the equity markets, MSCI DM fell -10.5% in 2018. As measured by MSCI, the US did relatively well at -7%. Austria was the worst DM performer at -26.5%, followed by Belgium (-25%) and Ireland (-23%). Ahead of the US, the best performers were New Zealand (-1%), Finland (-2%), and Australia (-6.5%).

What’s in store for the dollar in 2019? If our call that US recession fears are overdone, then we would expect US rates markets to adjust accordingly and back up. The implied yield on the January 2020 Fed Funds futures contract ended the year at 2.38%, which suggests no Fed hikes this year whatsoever. This seems way too dovish. Indeed, the Fed Funds futures strip is now pricing in rate cuts in early 2020.

When (if?) US rates back up again, the dollar should regain some traction. Until that happens, however, the greenback is likely to remain vulnerable to further selling. What’s limiting the dollar’s losses for now is that the economic outlook in the rest of the world is deteriorating just as much. Counterintuitively, if US rates back up due to falling recession fears, then US equity markets could gain further traction.

The US shutdown continues into the New Year. The new Congress will be seated Thursday, at which time the Democratic-led House is likely to pass two bills that will allow the partial shutdown to be lifted. One will reportedly reopen eight departments and fund them through September, while the other will reopen the Department of Homeland Security until February 8.

Both houses held a brief session Monday and will hold another Wednesday with no votes planned. Republican Senate leaders said they will not pass any House bills that do not contain the $5 bln in funding for the border wall that President Trump is demanding. The House bill would only contain $1.3 bln for border security that was in the bill that the Senate passed last month before Trump upended the process.

The US economy remains firm. December Chicago PMI came in stronger than expected at 65.4. The Atlanta Fed’s GDPNow model is tracking Q4 growth at 2.7% SAAR, while the New York Fed’s Nowcast model is tracking 2.5% SAAR. December ISM manufacturing will be reported Thursday and is expected to fall to 57.6 from 59.3 in November.

December auto sales and ADP jobs will also be reported Thursday, but the main event is the jobs report Friday. Nonfarm payrolls are expected to recover to 180k from 155k in November, but average hourly earnings are expected to fall a tick to 3.0% y/y. CPI data will be reported next Friday.

There are several Fed speakers at the American Economic Association meeting in Atlanta. Powell will be interviewed along with his predecessors Yellen and Bernanke Friday. Williams, Bostic, and Daly then speak Saturday. The next FOMC meeting is January 30. While no move is expected, there will now be a press conference after every meeting. We expect the Fed to carefully control its messaging this year considering the market gyrations seen in Q4.

President Trump signaled a possible thaw in US-China relations. Trump and Xi reportedly had a long telephone conversation over the weekend, and Trump later cited “big progress” in trade talks. He added that talks were “moving along very well” while Chinese state media said Xi believes both sides want “stable progress.” No further details have been released. A US trade delegation travels to Beijing next week.

The Chinese economy continues to slow. On Monday, official manufacturing PMI fell to 49.4 in December from 50.0 in November. This was the first sub-50 reading since July 2016 and the lowest since February 2016, although the composite PMI only fell to 52.6 due to a rise in the non-manufacturing PMI to 53.8. Caixin PMI reading will be reported Wednesday, and we see downside risks to the consensus 50.2 that’s steady from November.

German preliminary December CPI inflation fell to 1.7% y/y vs. 1.9% expected and 2.3% in November. This is the lowest reading since April and will surely pull down the headline eurozone reading. That data will be reported Friday and we see downside risks to the expected 1.8% y/y. Ahead of CPI, final eurozone PMI readings will be released Wednesday and are expected to show continued weakness in the economy.

The next ECB meeting is January 24. While Draghi signaled steady as she goes in terms of hiking rates after the summer, continued softness in the eurozone data will continue to raise doubts that this will occur. We think the ECB will be keen to see how the end of QE impacts the economy and markets as 2019 gets under way.

UK Prime Minister May has reportedly been in talks with EU officials over the Christmas break. Even though the UK parliament is on recess until Monday, May is clearly trying to line up further concessions from the EU ahead of the planned vote later this month. However, the EU has made it clear that no significant concessions will be made to secure UK parliamentary approval.

UK manufacturing PMI will be reported tomorrow, followed by construction PMI Thursday and then the services and composite PMIs Friday. The first two are expected to worsen while the services PMI is expected to improve, thereby pulling up the composite reading by a tick to an expected 50.8. Next BOE meeting is February 7, and it’s clear that its hands are tied until the UK exits the EU in March, deal or no deal.

Japan reported soft data for November and December. The unemployment rate ticked up to 2.5% in November, while December Tokyo CPI eased to 0.3% y/y vs. 0.5% expected and 0.8% in November. This suggests downside risks to national CPI when it is reported January 17. November retail and supermarket sales also came in weaker than expected. The BOJ just affirmed its commitment to keep stimulus in place until at least 2021 and will likely reaffirm it at the next meeting January 23.

Korea reported weak December data that could be a harbinger for the rest of EM. Exports contracted -1.2% y/y rather than growing the expected 2.5% y/y, while imports rose less than 1% y/y. CPI inflation eased to 1.3% y/y rather than the expected 1.7% and down sharply from 2% in November. The BOK just hiked rates last month, but the data support our view that it is unlikely to hike again for quite some time doe to downside growth risks.

Jair Bolsonaro was sworn in as the new president of Brazil. He inherits a weak economy amidst high market expectations for passing much-needed structural reforms. We suspect like the case of AMLO in Mexico, investors will end up being disappointed. Markets have pushed out expectations for the first rate hike from COPOM until Q3 2019. December trade data will be reported sometime this week.

EM FX took a battering in 2018. For the year, only THB eked out a small gain (0.1%). MXN was basically flat, while the worst performers were ARS (-50.5%), TRY (-28%), RUB (-17%), BRL (-14.5%), and ZAR (-14%). This iteration of the Fragile Five is likely to remain in place due to idiosyncratic political and economic risks that should continue in 2019.

Looking at the equity markets, MSCI EM fell -16.5% in 2018. Latin American outperformed (-9%) while Asia (-17%) and EMEA underperformed (-18.5%). As measured by MSCI, Argentina was the worst performer at -53% followed by Chile (-21%) and China (-20%). The best performers were Qatar (+24%) and Saudi Arabia (+15%).

What’s in store for EM in 2019? Some may take comfort in reduced expectations for Fed tightening this year. However, that comes within the context of slower US growth. That in turn comes within an even broader context of slower global growth, with China, eurozone, and Japan all likely to surprise on the downside in 2019. This is not conducive for EM and we expect further losses this year.