Policy divergence means straightforward outlook for currencies ? It's NEVER that simple.....
Tuesday
1st December 2015
Policy
divergence means straightforward outlook for currencies ? It's NEVER that
simple.....
Ref : "Forex
forecast clouded by policy fallout" , Markets outlook 2016, The Financial
Times, p.30
As we all know only too well by now,
the next 15 days will see monetary policy decisions from the European
Central Bank, the Swiss National Bank and the US Federal Reserve, in that
order. In normal circumstances it might seem like a dangerous time to have
to broadcast one's view on foreign exchange markets for next year, but the
intentions of these central banks have been well signposted. Most , but
crucially not all, are happy to draw the obvious conclusions from the widening
interest rate differentials that are likely to be the result of these policy
decisions.
Very broadly speaking, there are some
general views that are widely subscribed to. Rising US rates (at a time when
rates elsewhere are on hold or falling, even into markedly negative territory)
will mean a strong US dollar. A strong dollar and higher rates will be bad news
for emerging markets who carry so much debt in that currency so expect EM
currencies to stay weak, particularly since they will also be undermined by a
continuing Chinese slowdown. Weakness in China's yuan / renminbi will be
exacerbated by the fact that now the yuan has gained reserve currency
status at the IMF, China's authorities will feel less obliged to intervene
on its behalf in FX markets, and will allow it to move more freely.
Sounds pretty logical, doesn't it .....
simple, even ? But what about the argument that diverging monetary policy
(tightening in the States, easy or easing virtually everywhere else) has been
obvious for some time, and that it must to a large degree be already priced in
to the market ? Is the dollar not in danger of getting overbought ? There are
many different measures of whether something is overbought or oversold : net
long/short open position reports, momentum indicators and relative strength
indices for example but it's important to remember that just because is
overbought does not mean that it can't go higher. For what it's worth, the
measures suggest that the dollar is mildly overbought but not so on a
wider historical basis.
Does that means that the way's clear for
an ever-strengthening dollar, then ? Well, that will probably come down to
what happens after the Fed meeting on Dec 16th, and the pace of any
further rate rises. It's worth having a look at the table that the FT has put
together showing where 5 major global banks think some key exchange rates will
be in a year's time :
Current rates
: Euro / US$ 1.0595
US$
/ JY 123.10
US$
/ Yuan 6.3980
Euro
/ US$ US$
/
JY US$
/ Yuan
JP
Morgan
1.13 110 6.70
SocGen
1.00 125
6.80
RBCCM 1.02 128
6.95
BNP
Paribas 1.02 134
6.70
Nomura 1.00 130
6.75
They all seem agreed that the Yuan is
going to weaken, and whilst four go for a slightly stronger dollar against the
Euro and Jap Yen, JP Morgan has called the dollar significantly weaker.
Behind their thinking may well be the problems that excessive dollar
strength could cause : declining exports harming growth , and the strong
currency creating disinflation. As they point out, one weak quarter could be
enough to stop the rate-rising cycle in its tracks.
And then there's our old friend the carry
trade ..... Currencies with negative rates like the Euro and the Yen
have become the funding currency, sold to purchase another with
higher-yielding returns. If there's another global shock (and who would be
brave enough to say there won't be?), risk aversion could cause sharp
rises in those funding currencies as the carry trades are reversed.
So, in answer to the original question
: No, it's not that straightforward .... but then no one really expected
it to be , did they ?
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