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British pound was the most volatile G10 currency last year with the trade weighted index plunging -15% on annual basis, despite a -5% rebound from the October low. Sterling fell about -16% against both US dollar and the euro for the year. The huge volatility was mainly driven by political reasons: Brexit referendum, resignation of David Cameron, as succession of Theresa May, as Prime Minster, as well as May's announcement to trigger Article 30, followed High Court's ruling that MPs must be consulted before triggering Brexit. In 2017, political risks should continue to haunt UK's economic developments as Brexit negotiations are prone to begin. The market has recently priced in higher BOE rate expectations due to rising inflation outlook and solid dataflow. Yet, we do not believe any rate hike would be adopted. The central bank would stand on the sideline, maintaining the bank rate at 0.25%, throughout the year. We are bearish over sterling, forecasting it to depreciate against USD and be range-bounded around current levels against the euro, which has been pressured by elevated political risks

Subdued economic growth and unconventional easing measures resulted in EURUSD's third consecutive yearly decline, although the loss was greatly trimmed to about -3%, last year. EURGBP, however, jumped +16% as sterling slumped on concerns over British economic outlook after Brexit. Risk is to the downside for the single currency in 2017 as pressured by elevated political uncertainties and ECB's dovish tapering stance. Recent upside surprises on inflation data would not make ECB less dovish. Core inflation remained weak and should only improve gradually this year, not sufficient for the central bank to commit to tapering. A break below the 1.0463 low in March 2015 has paved the way for EURUSD to go further lower. We expect EURUSD to reach parity by 2Q17, probably after French election.

2017 is year of high uncertainty, mainly hinging on the shift of global political agendas, from the new policy direction under Trump's administration, to the beginning of negotiations between the UK and the EU on Brexit, to the leadership transition in China. On the currency outlook, we remain constructive over USD this year, anticipating Trump's pro-growth policy would drive higher economic expansion and inflation, and facilitate a tighter monetary policy stance. With the market shy of pricing in three Fed funds rate hikes (as signaled in the December dot plot) this year, there is room for USD to rally further should incoming macroeconomic data eventually convince traders that more rate hikes are possible. We are bearish on Treasuries and expect US yields to move higher, especially at the front-end. Monetary policy divergence should bold well for the greenback, especially against the euro.

The recent selloff in Japanese yen and widening in US-Japan yield differentials have been driven by the FOMC rate hike and expectations of further tightening in US monetary policy. Indeed, BOJ’s action has minimal impact on the phenomena of late. BOJ on Tuesday left its interest rate targets unchanged with the short-term and -10 bps and the 10-year JGB yield at around 0%. The asset purchase program also stays at approximately 80 trillion yen of JGBs annually. The central bank also upgraded its current economic assessment and outlook.

To the market's surprise, OPEC announced to cut production to 32.5M bpd, the lower end of the target range indicated in the "Algiers Accord" in September. It also represents a -1.2M bpd, or -3.7%, reduction from October levels. Meanwhile, OPEC noted that non-OPEC countries have also agreed to cut output by -0.6M bpd with half of the contribution coming from Russia. Initial market reaction was buoyant with crude oil prices rallying the highest levels in a month. However, performance of commodity currencies under our coverage was not as robust as expected. Indeed, all of aussie, kiwi and loonie ended the day lower after initial rally, mainly due to a stronger US dollar. Higher oil prices as a result of output cut lift inflation expectations, lifting US dollar and Treasury yields.

Following Brexit and Donald Trump's victory in US presidential election, the Italian referendum this coming Sunday is the latest event that could cause huge volatility in the financial markets. Indeed, with the "no" camp leading in opinion polls, Italian shares and bonds have underperformed of late. The banking sector has suffered most with the FTSE Italia Banks Index losing almost -9% in November. Italy's FTSE MIB index has fallen -2.65% this month, compared with a -0.74% drop in the pan-European Stoxx600 index. Meanwhile, the 10-year Italian/German yield spread widened to a 1.5-year high of 1.874% last Thursday. The market's key concern is that a "no" vote leading to resignation of Prime Minister Matteo Renzi would trigger massive selloff in bank shares, forcing the debt-ridden Banca Monte dei Paschi di Siena to suspend plans for a critical 5B euro capital increase and then making other banks, such as UniCredit, to delay similar plains too. Such risks might be contagious, spreading to other peripheral countries and result in another European financial crisis.