Crunch time for currencies ahead of pivotal Q4
FX market turbulence in August, led by sharp moves in emerging market currencies, has so far in September given way to more placid price action.
The Dollar has weakened, Nordic and in particular high-yielding emerging market currencies have on the whole appreciated while Asian currencies have underperformed.
Since 4th September, all major currencies, bar the Philippines Peso, Yen, Indian Rupee and Renminbi have appreciated versus the Dollar. The Dollar Nominal Effective Exchange Rate is down 1.2% to a one-month low, in contrast to its 7.4% gain in the prior five months.
Market pricing of Fed hikes for the rest of the year has only risen marginally to about 47bp currently, in line with our view (see Herd instinct giving way to phased FX approach, 31 August 2018). Strong US macro data have pushed up market pricing for Fed hikes in 2019 to about 48bp but this has failed to stop the Dollar’s slow grind weaker.
For starters, US yields surged over 20bp in September on heightened expectations of Fed rate hikes but so have yields in other major developed and emerging market economies where central banks have been hiking rates and could conceivably hike rates further.
Even in developed economies where central banks are unlikely to hike rates in the next few months, including Australia, New Zealand, Switzerland and Sweden, currencies have recently benefited from the release of strong domestic macro data.
Finally the Dollar has since early August lost the benefit of a depreciating Renminbi, as per our expectations (see Central Banks’ Guns & Roses (and inaction), 26 July 2018).
Near-term, we think the relative strength of the US economy and market pricing of Fed rate hikes will provide a decent floor under the Dollar.
However, the outlook for the Dollar and other major currencies remains cloudy in coming months given sizeable event risk, including US mid-term elections in November, a likely crescendo in Brexit negotiations and the start of the ECB’s tapering of its QE program. As markets head into 2019 the Dollar could become more vulnerable, in our view.
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Olivier is an economist and rates & FX strategist with over 22 years experience in financial markets. He is Director and Founder of 4X Global Research, an independent, London-based consultancy which provides institutional and corporate clients with substantive research, high-quality analysis and insight on emerging and G20 economies and financial markets.