Top FX trades and themes for 2018

Richard Falkenhäll, Senior FX Strategist at SEB discusses the top FX trades and themes for 2018:

“The synchronised global recovery is set to continue in 2018. Generally, we now see a growth dynamic typical of a mature expansion period. Robust labour markets and increasing wealth support our positive view. This is usually an environment in which volatilities should remain under pressure while risk appetite retains support. Low volatility is a key factor for carry trades. However, the carry trade also rests on the carry or rate differential. Generally these still seem too low to justify a carry position, regardless of low volatilities. However, using the euro as a prime funding currency there is a possibility that the rate differential will be large enough to rationalise a carry trade.

“Perhaps not as much as in 2017, but politics and political decisions will continue to influence currencies in 2018. In Brussels, Brexit negotiations between the EU and the UK continue. So far progress has been slow but we believe this is more due to the nature of these kinds of talks than a reflection of unwillingness to reach a deal on exit conditions and the future relationship between the parties. As the GBP still trades with a significant risk premium, the currency would recover substantially if talks end in a deal in 2018.

“Being contrarian could certainly be the way in 2018 and in line with this belief we forecast the USD to appreciate against the CAD which is against most predictions that the dollar is projected to depreciate against all currencies in 2018. Another way would simply be to go against the widespread idea that the SEK will recover next year, which is the most obvious consensus view right now. Perhaps it will not fall but rather stay around today’s level. A less positive global growth scenario would add further support to this trade as the SEK tends to react negatively to falling risk appetite.  In Sweden, new national elections will take place on 9 September 2018. It is hard to explain why but since 1994 EUR/SEK has traded in a narrow range around 9.20 on election days. It’s possible to consider a rationale that there will be a sell off of EUR/SEK ahead of the election as traders bet history will repeat itself.

“In the US, the recovery has been under way for more than eight years and our forecast suggests it will continue beyond all previous business cycles. Historically, yield curve inversions have been the best recession indicator in the country. This year the yield curve has flattened significantly and the recession risk has increased to 10%. Previously, a probability around 20% has been enough to foresee a recession. While we may be deceived this time around as the long end of yield curves might be distorted by central banks, it could still represent an early warning signal.

“Monetary policy and signals from central banks have been key for currencies for several years. In 2018, we expect more central banks to cautiously follow the Fed and tighten monetary policy. If these hikes are delivered it should provide support for those currencies. Should they take place, hikes by Norges Bank and the Riksbank towards the end of 2018 would offer a welcome boost to Scandies currencies. Otherwise, with more central banks taking small steps towards normalising policy the exclusivity of the Fed will dissipate, potentially contributing to renewed dollar weakness next year.”