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Making sense of global FX trends
YOU used to be able to find a strong foreign exchange (FX) trend in the past couple of years, and trade the currencies accordingly. But this year feels different. There is no longer a dominant US dollar trend, premised on US rate hike expectations or cutbacks in large scale asset purchases. That has more or less sneaked into the background.
A clear US dollar inclination in either direction requires a new catalyst, although we should expect US dollar weakness over strength at least for this year. This is because it is increasingly difficult to make the case for further US interest rate hikes because of several factors. First, the US economy posted a spate of mixed economic data recently, indicating spotty growth recovery. Second, the risk-off market correction in the first six weeks of 2016 has gone on longer than expected, heightening the downside risks of rate tightening on the economy. Third, with cheap oil anchoring inflation expectations, policymakers have room to either hold off on further rate increases or push for more easing.
The FX implications are that the long US dollar trade has lost its bearings. According to the latest ANZ report on speculative CFTC position, leveraged funds continued to sell US dollars in the week to Feb 16. Total net long US dollar positions fell for the third straight week, down by US$5.6 billion to US$14 billion. The majority of the selling was against the euro and Japanese yen.
This is not to say that monetary policy divergence expectations underpinning US dollar strength in the recent past have disappeared, but rather, the theme is settling into the shadows. Instead of pulling at opposite ends of the hawk-dove divide, there is now only pressure for the European Central bank (ECB) and Bank of Japan (BOJ) to do more to spur inflation and support growth, while markets increasingly expect the US Federal Reserve to stay put.
But here lies the challenge. The venture into negative interest rates by ECB, BOJ and several other smaller central banks, signalled to the markets that they are losing their capability to tackle global economic ills. Put differently, central bank efficacy is being called into question now. This is why the euro and yen are stronger despite the easing bias of the ECB and BOJ.
Meanwhile, the big issues on the global agenda remain oil, China and the world economic conditions. The excess oil supply is anticipated to last for many more months before we see relief. The inability for major oil producers to agree to a production cut underscores the classic Prisoner's Dilemma situation that they are in.
The weak oil prices are expected to keep oil-sensitive currencies in oversold conditions and under pressure. The Canadian dollar and Norwegian krone remained at 13-year lows. However, oil prices may be perceived to be close to their bottom after falling around 70 per cent since June 2014. Should this view hold true, then we could see a bit of a bounce in the Canadian dollar and Norwegian krone.
Concerns over the impact of yuan devaluation has made the US dollar/yuan one of the most important exchange rate in the world. The CFETS RMB index showed a weakening of around 1.5 per cent on a basket basis since the start of the year till Feb 19. China has been attempting to stabilise the currency for a period of time, when sentiments towards the yuan became too bearish. However, slowing growth and deflation risk meant that further yuan weakness may be more possible than improbable.
Trading the G-10 currencies seems very difficult in the absence of sustained trends. But there are a couple of developments which warrant some thoughts.
The exit of Britain from the European Union, the so-called Brexit, is a clear and present downside risk for the sterling pound. The fallout from such a scenario would be so distressing that most economists polled in a Bloomberg survey expect it to sink to 1985 levels within a week of a vote to exit, or around US$1.35. The pound has recently traded below US$1.40 against the US dollar.
Apart from Brexit fears, a tepid economic recovery and a lower probability of an interest rate increase saw the trade-weighted pound weaken over 5 per cent in the first seven weeks of 2016. British Prime Minister David Cameron announced that the referendum on the UK's membership in the EU will take place on June 23. It is quite likely that we shall see more pound volatility in the interim.
The NZ dollar may also come under renewed pressure, not only on low commodity prices but also on the grounds that the Reserve Bank of New Zealand sees further room for currency depreciation after its January policy meeting. Threats to the bank's inflation target of 1-3 per cent suggest that more easing may be appropriate.
- The writer is Market Strategist, IG Asia