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Forex 2018
INTRODUCTION
The outlook for the foreign exchange market in 2018 is, like any market, dependent on the interaction and trends of
FITS (fundamentals, intermarket relationships, technical and sentiment). This interaction explains why currencies
can and frequently move away from their traditionally significant interest differentials in the short to near term as
the Euro has done since July. It certainly explains why some currencies like the CHF seem to ignore their purchasing
power parity (PPP) for prolonged periods. It also accounts for the underestimation of, once theoretically important,
trade flows even though the currency of the country with the largest current account deficits, the United States, was
amongst 2017’s worst performers. It also crucially explains why the USD has lost its risk status (correlation to SPX) in
2017.
How a combination of the four FITS pillars manifests itself contributes to, but also depends on, volatility and
therefore clarity (VC). Movements in volatile (particularly fundamental) trends tend to be clearer than consolidation
markets, at least in retrospect. Although any of these factors can be obscured in the forex market as currencies are
expressed in terms of another currency (or basket eg DXY), when one of the FITS of any market is dominant it tends
to supersede all others. Sterling’s sentiment driven Brexit collapse in June 2016 still casts a long shadow over the
Cable market and indeed the UK economy.
The Fundamental prospect of Trumpflationary growth drove the USD higher against most other currencies into
2017. In contrast to the equity markets, it was then reversed even against the Brexit beleaguered GBP for most of
the year partly because US inflation did not rise to the extent either the Fed or traders’ anticipated. This
overestimation was also compounded by Trump’s wish for a weaker dollar combined with political uncertainty at
home and abroad. Adding to the dollar’s woes, was the ‘Sintra pact’ in June that saw a co-ordinated step towards
tightening by the ECB, the BoE and the BoC, and paved the way for all three banks making hawkish policy changes
later in the year.
The main beneficiary was the Euro. The ECB was notably sluggish in announcing the tapering of its quantitative
easing programme even though the European economy continued to recover and shrugged off political concerns
surrounding Brexit and French/German elections and even Catalonia. Whereas the persistent campaign of the SNB
has ensured prolonged CHF weakness against the Euro and stability versus the similarly weak Dollar. Despite bouts
of two-way Brexit inspired volatility, Sterling remained stable to strong throughout the year. Our theory, that
uncertainty about uncertainty creates inertia until it is resolved either way, has been borne out. When Brexit news
hasn’t been forthcoming a surprisingly resilient economy and inflation outlook has helped maintain the GBPUSD
updrift. A self-correcting irony: Sterling weakness had pushed inflation up to 3.1% in turn helping the Pound to
recover.
Intermarket relationships for currencies have, at times, bordered on the bizarre. The three main links (interest rates
and the related commodities and risk appetite/aversion with stocks) have vacillated and varied as part of a general
market correlation break down. 10 year US yields have remained range bound around a 2.3% pivot all year and while
the Fed has raised three times now the Federal Funds Rate sits in the 1.25-1.5% range. Clearly the market is still
sceptical about sustained inflation and towards the end of the year the outgoing Fed Chair, Janet Yellen, admitted
she found the low inflation a ‘mystery’, a clear break from the previous message it was ‘transitory’.
Yield driven currency moves then can be explained partly by a change in the yield curve but more by uncorrelated
movements in other countries’ bond markets. For much of the year certain currency pairs have correlated strongly
with interest rates. EURUSD gripped its 10 year yield spread for the first six months until the July 20th ECB meeting
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but thereafter continued to rally while its differential downtrended for the rest of the year. Based on 10 year
interest yields alone EURUSD should have closed the year 900 pips lower! Thankfully we chose to ignore this.
USDCAD has been tied to its falling differential all year with any divergence proving momentary and often flagging a
reversal in the currency as it came back in line. Some of that divergence is due to Oil in Canada’s case but that in turn
has led to an associated movement in the Canadian bond market. The delayed reaction has often counterintuitively
seen the Canadian Dollar move in the opposite direction to Oil. Similarly, the Aussie has been buffeted by
commodity movement but typically with a time lag. Its 4.2% year end squeeze can mainly be attributed to Gold’s
recovery rather than only a 11 basis point differential rebound even though this started earlier in November. Politics
rather than milk has been the main driver of the Kiwi’s whipsaw trends and saw NZD ramp while its differential
collapsed in December. What is normally seen as a yield/risk appetite currency has ignored stock markets for much
of 2017. But the most interesting break down in correlation has been the apparent end of the 11 year bond between
USDJPY and the Nikkei, which we flagged as possibly our boldest currency prediction of 2017, and a precondition of
an end to deflation. Although this can in part be attributed to USDJPY’s more powerful correlation to 10 year yields,
it reflects a more general break down in traditional currency risk appetite/aversion relationships.
The root cause of the currency disconnect, we believe is the disintegration of the risk status of the world’s reserve
currency, the USD. At the end of 2017 the Dollar Index closed 10.55% lower and the S&P 20.6% higher. The last time
we saw such an inversion was at the start of the stock bull market in 2009 (due to Quantitative Easing). 2010 saw
them slowly but surely come back in line before both rallied for the ensuing 6 years. The consequence of 2017’s
breakdown has been varied and arguably bizarre. Those currency pairs that have stuck to their interest rate
differentials have traded as they would in risk aversion mode ie stocks falling. The prime examples would be EURUSD
strength and AUD weakness hence EURAUD strength. However other safe-haven / risk aversion pairs such as
EURCHF and JPY crosses have rallied diverging from their differentials in the last six months and reflecting stock
strength.
Traditional Technical Analysis of foreign exchange has been undermined by the weakness in the market’s glue.
Potentially significant breaks have frequently proved false at least in the shorter term with currencies rolling back
into their range. Once upon a time we could have blamed this on vega trading by options desks. But this time it is
symptomatic of a broken market. The Australian Dollar is probably the prime example in 2017 to the extent you
almost had to wait for a false break before it reversed. Similarly, the sequence of potentially abortive bearish
EURUSD Head and Shoulders patterns has ironically been a useful guide to nursing a bullish trade. 2017 has probably
set a record for redrawn trendlines and resurrected the ‘third trendline is a good one’ maxim. Although we are
generally not fans of daily or weekly close based analysis this has proved a safer and truer guide for genuine breaks
for much of 2017.The proliferation of wedges is also testimony to a market that is trying to trend but brought back
by opposite movements in other related markets. When markets behave like this it normally suggests they are being
influenced by larger flows in other currencies often where one of the FITS is more dominant.
Forewarned is forearmed. There are two powerful technical templates for the current forex market. US stock
markets have followed a slower (delayed) but consequently more aggressive version of their 1987 blowout. As we
have seen the Forex market behaved oddly but therefore very much like it did in 1987 without, as yet the dramatic
risk aversion finale associated with the 1987 stock crash. Although the forex outlook for 2018 would seem to beg
the question of whether indices (and therefore safe haven / risk aversion pairs) will turn, we are fortunate that many
currencies (notably the USD and particularly EURUSD, AUDUSD and GBPUSD) are also following very similar price
action in 2002-2003 – a period where stocks were flat to down before a larger recovery. In other words, there are
templates for the forex market that are not entirely dependent on (although influenced by) what the stock markets
do.
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There are many other weaker precedents for this type of market where intermarket and technical factors have
underperformed but they are normally seen at the end or indeed start of a major global trend where Sentiment has
become the main driving force. Extreme sentiment in a major market such as US indices will inevitably spill over into
other related markets due to stock related flows and stock associated sentiment. Traders will sell CHF and JPY in
order to fund purchase of higher yielding currencies/assets but also because those lower yielding currencies are
weak. This complicates sentiment analysis of foreign exchange as currency flows are no longer isolated; that is they
increasingly contain an additional stock or yield related element. A market such as the EUR may appear overly bullish
but new entrants may come in and buy significant amounts transforming a market that may indeed be long to one
that is net short but still bullish. This additional long term fund buying is probably the main reason for the growing
gap between EURUSD and its interest differential over the last six months. The irony and an interesting feature for
2018 is that should stocks turn, rather than provoke a liquidation of the long EURUSD trade, it could exaggerate the
uptrend.
As a consequence, forex sentiment has been confused for much of the year. It is natural to seek trend and quickly.
But a year of false breaks, slow trends or consolidations has seen currencies take out weak positions leaving the
market overly long or short and therefore retrace before resuming the pattern. 2017 may well go down as the year
of the Forex cynic or the hesitant Central Bank. Despite moments of astute presentation, the ECB has failed to grasp
the sentiment of the Forex market. They expressed concern on a number of occasions about the appreciation of the
Euro and seemingly delayed the long overdue Taper as a result. And yet this delay has itself fed Euro strength
denying the market its favorite ‘buy the rumor sell the fact’.
The outlook for 2018 therefore depends partly on whether these trends in FITS continue and therefore whether US
inflation and interest rates/yields will not rise as much as elsewhere. To appreciate what may happen in 2018
requires an understanding of where each country sits within its economic cycle compared to others but also the
attitude of Central Banks and their respective policies. Certainly the US has been at the forefront of economic
growth. It is not clear whether subdued US inflation reflects either a less than robust economy or an ecommerce
inspired change in the nature of inflation. But either way an historically slow US tightening phase has encouraged
central banks elsewhere to follow suit and dither and delay. This not only risks a shift in relative inflation rates and
consequently yields but may well serve to perpetuate trends they wish to avoid.
Two trends we do expect to see in 2018:
Firstly, just as stocks exceeded even our aggressively bullish targets for 2017, the Forex market has the potential to
regain volatility and exceed many expectations.
Secondly, just like 2010 the Forex market should slowly but surely come back together in 2018 — hopefully making
markets easier to trade and certainly to understand.
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EURUSD
Long EURUSD was our projected highlight for the latter part of 2017 and could well be for the next 4 years.
In 2016 we highlighted long EURUSD would be the Forex Trade of 2017 based on the Pandora’s Box Analogy we have followed
for much of this decade. This and the similar leading Gold (Washington Gold agreement) price action in 1999 argued the Euro
was setting a base within a repeating pattern in a rising wedge dating back to 1985 (when it was $-Deutschmark). This
suggested it would eventually secure another run at the highs once it regained weekly downtrend now at 1.2636. It also
projected an interim consolidation base 16 years after the previous consolidation base (that was also 16 years after the 1985
low). Furthermore, it forecast that, once the Euro broke the effective 1.1550 consolidation high this would be maintained in a
218-week uptrend– a major bull market – that characteristically aborted a bearish Head & Shoulders. Although the marginal
new low to 1.0340 at the start of 2017 was slightly out of synch, EURUSD subsequently proved it was still following this pattern
and therefore an uptrend driven by economic resurgence in Europe, a catch up with the US and a relative firmly of yields. Indeed
this yield view is supported by the long term Matrix currency fractal (where 3 month forwards are leading the EURUSD higher -
see below).
We therefore remain bullish the Euro potentially for a break of
1.2635 to confirm at least 1.3710-1.40. The timing of any
upward acceleration and therefore likely high for 2018 depends
partly on the structure of the rally (and possibly stock
disinvestment from the US) and the extent to which the Italian
elections early March will serve as a brake (Note the French
Elections in 2017 initially slowed the uptrend but then gave it
later impetus). With an outstanding six month target from 2017
of 1.2340 we may have to tolerate a period of 1.1550-1.2635
consolidation before the uptrend can gather momentum even
though history favors a continued uptren
A loss of 1.1550 would suggest 1.11 in a deeper correction but only a break of the 1.0340 low aborts this long-term pattern for
an aggressive spike sub parity.
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USDJPY
There is surprisingly little change in our view from 2017 as USDJPY has spent 43 weeks of the last year in a 107.35-114.70 range
and therefore sits neatly but perhaps disappointing in a potential consolidation top. Context is important to understanding what
this represents. Within a 20-year 75-145 prolonged consolidation the 50 yen USDJPY rally following the 2011 earthquake should
represent the first leg of another run at the 145 high. The 50% pullback to 99.10 was easily enough in distance to satisfy the
correction.
Although it is therefore easy to believe the current impulsive recovery is a resumption of that uptrend, both our so far successful
Earthquake template and a very similar impulsive recovery in 2000 suggest this could be the early stages of at least prolonged
consolidation in the 100-125 range if not a potentially larger albeit corrective decline. The longer USDJPY can stay below ideally
114.70 now but more significantly 125.80 then not only can we expect a return to 99.15 but possibly breaking down to 94.75
(61.8%) even 87.40 (76.4%) in a possible continued reflation inspired disconnect with the Nikkei. It is therefore only after a
longer and/or deeper correction that we can see USDJPY break the 125.80 high although a rally through 114.70 and 118.90
would increase the probability of a premature test/break.
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GBPUSD
GBPUSD stands out as the currency pair with the greatest potential to surprise with a Brexit unwind in 2018, particularly after a
possible period of general Sterling weakness at the start of the year. Following what appears to be a possibly complete three
legged decline from the 2.1160 2007 high, the Fat Finger spike to 1.1815 (possibly lower) marks a potential base from a recovery
back through the pre Brexit referendum lows of 1.3653-1.3833 initially back to 1.4320 (50% but with potential for a return to the
pre Brexit high of 1.50 (61.8%) and potential downchannel resistance. In this respect a continued similarity to the 2001-2007
uptrend is instructive. So although we could tolerate further consolidation below 1.3654 even to the extent of spiking below
1.30 to 1.2775-1.2815, while GBPUSD is above 1.25 then there will remain a window to resume a potential six year uptrend. A
surprising thumbs up for Brexit?!
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EURGBP
EURGBP remains within in a longer term uptrend reflecting inherent weakness that predates Brexit.
Following a clearly corrective seven year retracement from 0.9800 to 0.6945 the impulsive recovery to the Fat Finger high of
0.9365 (following similar price action to the UK’s exit from the ERM in 1992) should represent the first of a three-legged move in
a rising wedge to a 1.0577 equality target. However, that 24 cent uptrend needs to be corrected. So although EURGBP has
settled into a Brexit uncertainty stasis in a 0.8300-0.9365 range this should eventually give way to a deeper correction in 2017 to
a current 0.8245 (c=a) equality target probably an ideal 0.8148 50% an even as low as 0.0.7860 61.8%? Once the current 0.83
consolidation is spiked and regained EURGBP will be in a position to break 0.9365 to challenge the 0.98 high. This corrective
consolidation phase is supported by the remarkably accurate Matrix Currency Fractal (3 month EURGBP forward) that
discounted the Leave scenario when the referendum was called in February 2016.
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USDCAD
Within an obvious and broad 0.90-1.60 long term range, USDCAD remains within an oil and interest rate driven downtrend to at
least 1.1410 (61.8%) and probably 1.1035 likely channel support and the same size of the previous decline. Despite the
persistence of the not dissimilar 2008-2011 downward ratchet it is no surprise to find the sell of from 1.4690 taking the form a
declining wedge. SO although this allows a period of approximate 1.20-1.30 equilibrium consolidation rallies should continue to
fade in the 1.29-1.31 region for an eventual break down through 1.1915 to the next objective at 1.1540 (c=a)
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AUDUSD
AUDUSD continues within a steady upward ratchet from the 0.6835 low that maintains a 2001-2004 inspired window to
accelerate at some point through the pivotal 0.8430-0.8660 to at least 0.9455 61.8%. Although this recovery appears labored
and therefore possibly corrective it is typical of one of Aussie’s favorite formations: the leading diagonal or wedge. Therefore
even though this suggests a potential spike only of 0.8160 in 2018 possibly failing below 0.8430, we expect an approximate 75-
84 range for much of the year to create a base from which to gather upward momentum. Although a loss of 75 would appear at
odds with the 2002 template only a loss of 0.7140 threatens to break the 0.6830 low down to 60.
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NZDUSD
In a politically inspired contrast to AUDUSD, the New Zealand Dollar remains within a flat 0.6230-0.7560 range. Although this
consolidation reflects a loss of upward momentum for an eventual break back up to retest but probably fail the 0.84-0.8840
highs, it does allow scope for a spike of 0.6233 later in 2018 but probably no further than 0.5784 (61.8%). A loss though of
0.5515 (equality with the 2008 risk aversion decline) would argue for a retest of the 0.4890 2009 low.
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APPENDICES
Here we present charts (in alphabetical order) for cross pairs derived from the USD primaries.
AUDCAD
AUDCHF
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AUDJPY
AUDNZD
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CHFJPY
DXY
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EURAUD
EURCAD
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EURCHF
EURJPY
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EURNZD
GBPAUD
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GBPCAD
GBPCHF
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GBPJPY
GBPNZD
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NZDJPY
USDCHF
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