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ANALYSIS: 2017’s key currency conundrums

The massive moves in the renminbi in the past few days have wrong-footed China bears and underscored yet again the size of the role currencies are likely to play in investment returns this year.

From China’s point of view, he said, the country will continue to monitor the currency level and the addition of a number new emerging market currencies to the renminbi basket is likely to make  index even more pro-cyclical.

“I wouldn’t be surprised if the market starts focusing more on the real prospect of china moving to a much more freely floated exchange rate mechanism. The question for markets is whether that will be done in a controlled or uncontrolled fashion.

For Edwards the decision to add 13 new currencies to their basket is a clear attempt to help control the pace of devaluation.

“By adding the Korean won (with a massive 10.8% weight) as well as the South African rand, Turkish lira and Mexican peso, their intent is clear. In the event of another EM currency rout, like that seen in 2015, the Chinese renminbi will now be joining in!”

There is an increasing bifurcation between those investors of the view that China is going to implode and those that feel that things can carry on going up for much longer than many expect, underpinned by a determined ruling class with their hands on the reins of what remains a command economy. But, how the currency reacts within that is going to be an important factor to watch. 

The mighty dollar

For Cobon, while the outlook for China is important, the key call for 2017 is going to be the US, in particular when or if the “dollar dynamic changes shape”.

The market has perceived Trump’s victory to be an opportunity to buy US assets, he said, but questioned how sustainable the concomitant rise in the dollar is.

Should the rise in the dollar be matched by an increase in global growth and an uptick in global trade then the strong dollar will be a benign factor, he said, but added: “It is not obvious to us that you get a sustainably higher level of trend growth as a result of Trump’s proposed policies,” he said.

The problem, Cobon explained is that the market seems to have forgotten what a stronger dollar signifies absent a world of significantly higher trade and global growth.

“People have got excited about the PMIs being a bit stronger and turning around but the global trade issue seems to be a bit more structural than cyclical.”

Despite the fact that he is not yet president, Trump has succeeded not only in dividing a country, but also markets on just how long the rally he has inspired can continue. In both the above scenarios there is the likelihood that the dollar moves higher, but the factors driving it are crucial in what it will mean for the broader economy. 

Euro politics

Exactly how things will look once markets are able to judge Trump on more than just his Twitter feed remains to be seen but already the market seems to be dividing into two camps and choosing which side of the call you want to be on is liable to be a big one this year. 

The other currency likely to see major play this year is the euro. But, according to Cobon, it is unlikely to see major movement in the first half. But, as political action comes down the pipe in the latter stages of the year that could well change. 

Coram Asset Management’s James Sullivan said he expects the euro will come under significant pressure over the course of the year, as he is expecting significan political change within the region. As a result he is limiting exposure to the euro.

“Currency formed a major part of investment returns in 2016 and we are not through that period yet, ” he added. 

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