2018 was a phenomenal year for the U.S. dollar as the trade weighted Dollar Index rose more than 9 percent from its low in February. This strength drove all of the major currencies lower, from the euro to the Japanese yen and Australian dollar.
Nothing mattered more than the market's appetite for U.S. dollars in 2018. It determined where all of the major currencies were headed and had a significant impact on commodities. That influence on the market won't change in the year ahead, which is why the outlook for the dollar trumps all else.
As we begin 2019, here are three currencies to watch:
The good times are over for the dollar. The trend for the greenback shifted in 2018 when equities collapsed and the economy began to slow. Unfortunately there are no shortages of risks for the U.S. economy in the year ahead. Volatility is rising, borrowing costs are increasing, credit is tightening, housing is slowing and earnings growth is weakening. None of this is good for the greenback because businesses may become more conservative, which could lead to weaker spending and hiring.
Monetary policy could also pose a problem for the dollar. The Federal Reserve was the primary central bank raising interest rates in 2018, but that will change as other countries normalize monetary policy more aggressively. Interest rates and growth made the dollar a big winner in 2018 and these same drivers should continue in the year ahead. USD/JPY is the most vulnerable to a decline that could take the pair as low as 105.
2019 will be a defining moment for the British pound. The U.K. is scheduled to leave the European Union on March 29 and the terms of exit still haven't been decided. Prime Minister Theresa May survived a no confidence vote but she faces the monumental task of trying to pass her deal through Parliament in January.
Brexit now rests on the Irish backstop issue which essentially comes down to whether Northern Ireland will fall under EU rules in perpetuity or whether U.K. will be able to assert control over the territory sometime in the future. May's argument has come to this: it's the best deal the U.K. can get, and if Parliament does not approve it, the U.K. will face a hard Brexit which could be devastating to the U.K. economy.
From the EU, side, the issue is whether to abandon its principle of fully open borders within the union, or to simply play real-politic with Ms. May, force a failure of her deal and hope that that U.K. opts for a second referendum in face of economic catastrophe.
For the time being markets continue to believe that cooler heads will prevail and that the U.K. will remain within the customs union in 2019. However, the chaos and turmoil of British politics have undermined investor confidence and traders remain wary. If Parliament approves the deal, we could see GBP/USD jump to 1.30, but if the U.K. leaves the EU with no agreement, sterling could drop to 1.23.
As the euro celebrates its 20th birthday, there will be a lot of changes in the region. Jean Claude Juncker will step down as the head of the European Commission and Mario Draghi will leave his post as the President of the European Central Bank. These two men provided steady leadership through some challenging political and economic times and the world will be watching eagerly to see who will be their successors.
The past year has been a difficult one with growth floundering and political crises escalating in France, Spain and Italy. However, 2019 should be a much better year for growth with low interest rates, a weak currency and low oil prices providing a much needed boost to the economy. ECB President Draghi may also raise interest rates as a final farewell before he steps down in October. The prospect of stronger growth and monetary tightening means we could see the euro trade back up to 1.17 by the end of 2019.
Watching these headliner currencies means watching the pivotal economic events of 2019. How Brexit, market volatility and Federal Reserve actions play out will likely determine the direction of currency markets.
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