The most prominent theme in the world currency market in the past year has been the spectacular rise of the US dollar against the Euro, the Japanese yen, commodity currencies and above all, emerging markets. While September payrolls growth was below the 200,000 consensus at only 142,000, this miss will not prevent the Federal Reserve from increasing its overnight borrowing rate by 25 basis points in the December or January FOMC.
The US central bank has no choice. Retail sales, housing, the unemployment rate (now 5.1 per cent, a post Lehman low), consumer credit, wage growth all point to a rate hike, despite the deflation risk in Europe, Japan, China and the emerging markets. Economic momentum is accelerating. At 17.4 million (annualised) units, US auto sales are their highest since 2000, with both home sales and construction spending at post crisis highs.
The only two soft patches in the US economy are the mass job losses (down 102,000 in 2015) in US oil and gas drilling and sluggish export markets. Yet the consumer is 70 per cent of the American GDP while exports are barely 12 per cent. The Federal Reserve’s rate hike does not mean that it is turning “hawkish” on monetary policy, only that the recapitalised, profitable US banking system no longer needs emergency “lender of the last resort” lending.
The last interest rate hiking cycle (2004-6) under Dr Ben Bernanke saw the Fed Funds rate rise by 425 basis points. The 2016 monetary normalisation cycle will be far more muted, given the deflation risk that haunts vast swathes of the global economy. The Yellen Fed has a “dovish” bias and its monetary stance will evolve based on new data on job growth, inflation and even global growth. China’s economic decline and its impact on crude oil/metals/emerging markets will be a significant downside risk factor in future FOMC rate hikes. However, it is entirely possible that the Fed Funds rate could rise by 150 basis points in the “normalisation” cycle. This means King Dollar will continue to reign in Planet Forex.
US dollar strength (57 per cent of the US Dollar Index is the Euro) against the Euro is anchored by the economic growth and interest rate differentials between the US and the Eurozone. The sovereign debt crisis in Greece, China’s threat to EU exports and the Volkswagen emission scandal (auto and auto parts are 20 per cent of German exports and contribute one of seven jobs in the largest economy in the Old World, one third of the EU GDP) will mean that ECB President Dr Draghi will accelerate his current $1.6bn bond buying programme. This will increase the monetary divergence between the Fed and the ECB and thus increase bearish pressure on the Euro since the collapse in crude oil means negative headline inflation rates in the Eurozone. I expect the Euro to fall to 1.04-1.06 by year end 2015.
The Bank of England could be the first major global central bank to hike its policy rate after the Federal Reserve while US dollar strength has pressured sterling (cable) down to 1.51, I doubt if we will test April 2015 lows at 1.4566, despite current bearish momentum indicators. While cable could range trade between 1.48-1.52, sterling will rise on robust High Street consumer spending, a new home mortgage credit cycle and, ultimately, a base rate hike from Threadneedle Street in early 2016. This means sterling rises against the Euro, yen and commodity currencies such as the Norwegian kroner, the Australian and Canadian dollar.
The Swiss franc has traded in a tight 0.95-0.9750 range despite the spike in volatility and risk aversion spasms in the global capital markets in August and September. This suggests a diminishing role for the Swiss franc as a safe haven currency. It also means that, its volatility falls and global equities begin a new bull run, the Swiss franc would well depreciate to 1.02 against the US dollar as deflation risk forces the Swiss National Bank to accelerate its easy money policies.
The Japan yen traded in a narrow 118-120 range in September 2015 due to Wall Street’s nervous, unsettled state and a rise in volatility. Skepticism about structural reforms, the third law of Abenomics, has also led to a fall in net short yen speculative positions on the Chicago currency futures markets to only $2.5bn. However, Japan’s sovereign creditworthiness has begun to deteriorate with the Standard and Poors downgrade to “A+”. This will revive fears about deflation risk, Japan’s excessive public sector debt at 250 per cent of GDP and the developed world’s worst demographic trends. The balance of risk suggests the Bank of Japan will boost its asset purchase programme and increase its monetary base rise target to 100 trillion yen. This will lead to a fall in the Japanese yen to as low as 125-127, possibly with the year-end 2015.
The collapse in iron ore and thermal coal prices as well as China’s economic decline has led to epic falls in the Australian dollar, from 0.95 to 0.70 cents. The collapse of mining capex in Western Australia and Queensland has forced the Reserve Bank of Australia (RBA) to remain ultra-accommodative in its monetary policy.
The RBA cut its policy rate by 25 basis points to only 2 per cent in May 2015 and its minutes suggest increased concern for downside economic risk, thanks to China and Southeast Asia’s financial carnage. Australian CPI is only 1.5 per cent, well below the Canberra central bank’s 2-3 per cent target range. Since Chinese growth nor commodities prices have bottomed, the Australian dollar’s downside risk remains its post crisis lows at 0.63 cents. The Lucky Country did not have a lucky currency in 2015!