CURRENCIES ON SHAKY GROUND AS GLOBAL JITTERS MOUNT

Volatility in the global economy is impacting currencies

In the United States, the recent midterm elections has the makings of gridlock in Congress, while the US-China trade spat looks unlikely to be resolved anytime soon. Across the pond, the UK is bracing for a less-than-advantageous Brexit with the European Union, while Italy is facing a fiscal crisis.

Meanwhile, emerging markets are routed due to a combination of low growth, trade protectionism concerns and volatile oil prices

Amidst these challenges, the American dollar appears to be the biggest beneficiary. The greenback has surged 5.8% year to date against a basket of currencies in tandem with the US economy, which is outpacing growth in the developed world.

US real gross domestic product (GDP) increased at an annual rate of 3.5% in the third quarter of 2018, according to the "advance" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 4.2%.

But even that may not last as there are concerns that the US fiscal stimulus package is tapering off and the economy is left with a mounting deficit amid more political deadlock

In fiscal year 2018, the US budget deficit reached USD 779 billion – USD 113 billion more than the shortfall recorded in 2017, according to the Congressional Budget Office. “Measured as a share of GDP, the deficit increased to 3.8% in 2018, up from 3.5% in 2017 and 3.2% in 2016.”

And despite tariffs imposed by the US, China is defying the odds, for now. Chinese exports grew in October. While shipments to the US were maintained, exports to wider world grew even faster, suggesting that global demand is more resilient than expected.

A weaker Chinese yuan also helps the country’s exporters. Imports also beat expectations, powering ahead at 21.4% year on year in US dollar terms.

The US dollar has grown just over 7% against the Chinese yuan year to date. Beijing is expected to take measures to keep the yuan competitive

To mitigate impact from escalating trade tensions, People’s Bank of China (PBoC) has announced further cut in required reserve ratio by 1%, effectively injecting RMB 750 billion liquidity

RMB has slightly weakened against USD amidst still heightened trade tensions and on-track rate hike cycle in the US. However, defying expectations, export growth rose in October. While shipments to the US held up well, those to other parts of the world grew even faster, suggesting that global demand is more resilient than expected.

“More importantly, exports to the US are only one-fifth of China’s total exports and they actually lagged those to the other parts of the world,” according to Oxford Economics. “This suggests that global demand may be holding up better than feared, while a weaker Chinese yuan is also helping the country’s exporters – the currency has weakened on a trade-weighted basis as well as against the US dollar.”

Europe is also going through a rough patch after posting strong growth. The continent’s economy continued to expand in the first half of 2018, although at a slower-than-expected pace, specifically in its advanced region, according to the International Monetary Fund (IMF).

“Driven by domestic demand, economic activity continued to expand in the first half of 2018,” the IMF said in its latest health check of Europe’s economy. “But the outlook is less favourable, with several forces likely to hamper economic growth.”

The IMF also noted that high oil prices has dampened income, while manufacturing growth cycle is maturing amid a lacklustre global economy

Meanwhile, Italy’s new ruling coalition government is facing some challenges after its proposed spending plans intended to boost near-term growth was rejected by the European Union.

The American dollar has fallen 6.5% against the euro, but the currency may be fast losing steam. All these challenges in Europe mean risk to the economic outlook have increased.

“In the short term, escalating trade tensions and a sharp tightening in global financial conditions could undermine investment and weigh on growth,” said the IMF. “In the medium term, risks stem from delayed fiscal adjustment and structural reforms, demographic challenges, rising inequality, and declining trust in mainstream policies.”

The European Central Bank is expected to signal that it will hold rates until 2019, especially given the latest GDP contraction in Germany, which suggests a slowdown across the Eurozone is imminent.

However, ECB president Mario Draghi’s speech in November struck a positive tone as he characterised the eurozone economy as “resilient” and insisted that risks remain “balanced”. He essentially confirmed the end of the ECB’s asset purchases in December. Yet he also warned that a more uncertain economic outlook could impact firms’ margins, leading to a slower convergence towards its inflation target.

In the UK, prime minister Theresa May and European Union (EU) officials have agreed the draft text on Brexit withdrawal deal, putting the country a step closer to making an orderly departure from the EU in March 2019. But May now faces a tough job in securing parliamentary approval for the deal.

The UK sterling is down 4.9% against the US dollar, but up 1.71% against the euro.