Safe-haven status vs attractive interest rate yields? In a week where we have monetary policy meetings from the central banks of the UK, US, and Japan, let’s take a look at the mix of monetary policy decisions they are facing and potential impacts on their currencies. The one to look at first is the Federal Reserve. The US Dollar has long been seen as the ultimate safe-haven currency due to its status of being the world reserve currency issued by its most significant economy, at the centre of global financial networks. Although the 2008-2011 financial crisis originated in the US, its currency appreciated more than any other in that period, owing to its ‘safe haven’ status. This time around, with the global outlook worsening, the Fed has set the highest interest rates of all the major central banks, and even a potential pause on Wednesday will likely not have a significant negative effect on the currency. In times of a global economic slowdown investors need to protect their wealth by parking funds in currencies that will not face a significant depreciation. Equity markets typically dip as investors shed risky assets to acquire risk-off assets such as treasury bonds. These bonds need to be denominated in safe-haven currencies to prevent FX losses. With high yields, the US Dollar has both of these boxes ticked, so surely further Dollar appreciation is on the cards as the global slowdown continues? Speaking of safe-haven currencies, the number two for many years has been the Japanese Yen. Considered a very safe economy, flows to the Japanese Yen traditionally increase in times of crisis. The kicker this time around is Japan has faced nearly 30 years of economic stagnation, with the BoJ setting zero or negative interest rate yields to boost growth. Are markets going to continue to accept the Yen as viable alternative if confidence in the dollar is shaken? (As it was earlier this year with the regional banking crisis and yet another flirtation with a sovereign debt default.) Or will markets look to another currency considered a bit riskier but holding higher yield such as the Great British Pound? The Bank of England looks set to raise rates this week to match its counterpart the Fed at 5.5%. There’s no doubt confidence in GBP has been shaken through years of sluggish growth and its ugly exit from the European Union, but will this be counterbalanced by higher yields and the period of more sober politics we have seen under new-ish Prime Minister Rishi Sunak? During the latter part of this year and early next, it’s expected that the record central bank rate hikes we’ve experienced will begin to have negative consequences on economies. It remains to be seen which economies will suffer most and which currencies will lose and gain as a consequence. While history is always a good reference point, every crisis teaches us a new lesson and history rarely repeats itself in exactly the same manner. How investors trade off safety and yield is a lesson to look out for in the weeks and months ahead.
- The US Dollar posted a modest gain of 0.25% in the past week against a trade-weighted basket of its peers. This represents nine consecutive weeks of gains against its peers with global recessionary fears rising and a struggling China and Eurozone. In the past week we saw inflation exceed expectations on Wednesday and retail sales do the same on Thursday. Despite this, the dollar remained flat week on week on some positive China data releases and further promises of economic stimulus. The US Dollar has been driven upwards by two forces recently, the USA’s own robust domestic data and a worsening global outlook. A decline in the global economy has the effect of pushing flows back to the safe-haven dollar. Indeed, new data shows that record inflows of $1.5 trillion have poured into US money market funds in 2023 alone. The DXY index has now recovered to levels last seen in March before the regional banking crisis.
- Looking to the week ahead, we have a much-anticipated Fed Interest Rate Decision Meeting on Wednesday. Markets have priced in a pause due to recent steadying in inflation data and comments from Fed officials. Market participants will be mostly looking forward to the release of the new Fed dot plot projections and Fed chair Powell’s press conference for guidance on future rate expectations. Currently, markets have priced in a 30% chance of a further 25bp hike in the November or December meetings, but this will be revised either way on the Fed dot plot projections this Wednesday.
- Recent economic data and the rise in oil prices does point to further potential hikes, validating the Fed’s ‘higher for longer’ rhetoric and there is no denying that robust growth and tight labour markets leave more room for hikes as of now. Studies show, however, that interest rate hikes take 12-18 months to show their full effects on an economy. If the Chinese and European economies show signs of recovery and the negative effects of high interest rates cause further cracks in the US economy, there is certainly a case for a reversal in recent US Dollar strength. Let us not forget there are persistent issues in the US banking and commercial real estate sectors which have not gone away. All eyes will be on the Fed this Wednesday.
- In China we saw a positive week of data with industrial production, retail sales and unemployment data all beating expectations on Friday. The Renminbi has steadied somewhat just below the 7.3 mark against the dollar. It must be noted, however, that data releases are being cherry-picked by the government and there are still major doubts about the overall state of the economy. Further reports of delinquencies in the property sector and the knock-on effects for the shadow banking sector paint an uncertain picture. The Chinese shadow bank, Zhongrong, at the heart of concerns over missed payments to customers has lent money to several of the country’s struggling property developers, according to a published analysis of legal and company filings. The connections between Zhongrong, a giant of China’s $3tn shadow finance industry, and property developers have fueled fears of spillover effects from a slowdown in the real estate sector, which accounts for more than a quarter of China’s economic activity. There are no data releases of note from China in the coming week, so the direction of the Renminbi will rely on data elsewhere and reports of any further government intervention into the currency or overall economy.
- The Bank of Japan's policy meeting on Friday is the highlight of the week in Asia, after Governor Kazuo Ueda stoked speculation of an imminent move away from ultra-loose policy. Markets, however, are not predicting any chance of a rate rise in Friday’s meeting. A spate of recent weak personal spending and wage growth data is continuing to push the Yen weaker, towards the 150 mark against USD. Much of the inflationary trend has been imported inflation rather than being domestically driven within Japan. As a result, JPY strength will only be likely through BoJ intervention in the near to medium term with Fed rates set to stay above 5% until mid-2024. Ueda’s comments on Friday will have a big impact on the near-term trend for the Yen.
- The Aussie saw its first week of gains against the dollar since mid-August in a welcome turnaround for the struggling currency. Buoyed by positive data from China and further news of government stimulus there, AUD holders will hope for further retracement in its losses since mid-July highs of 0.69 vs USD. Data from last week showed unemployment remains extremely low at 3.7% and markets will be looking at Friday’s services and manufacturing PMIs to gauge activity levels within the economy. RBA minutes from its previous meeting will be released on Tuesday, which will be a good indicator on the internal thoughts of the central bank when it comes to the possibility of further rate hikes.
- INR weakened beyond 83 versus US Dollar last week on stronger than expected US data and a decline in Indian inflation and manufacturing. This is in line with the managed downtrend of the Rupee against the dollar and the Fed rate decision this Wednesday will likely determine the direction of the Rupee in the absence of any data prints of note this week.
- PKR enjoyed its first week of gains against the dollar since early July, appreciating by 2.1% to 296.85. The currency closed positive on all five days, extending its winning run to eight successive sessions as momentum continued to favour the rupee. The change in fortune comes as authorities introduced some reforms in the Exchange Companies’ sector and reportedly cracked down on smuggling, lending support to the currency markets. During the week, the State Bank of Pakistan (SBP) reported lower foreign exchange reserves and a current account deficit of $160 million in August 2023 compared to $775 million in July 2023 and $774 million in August 2022. A much-needed boost to the struggling Rupee.
- Nigerian Naira official rates remain in a stable trading range since the June devaluation of the currency, with a midpoint of 760 vs USD. The major news from Nigeria last week was a news release following a meeting with the UAE government that visa bans will be lifted, and flight are set to resume to the emirates. The UAE has since denied any agreement being reached in an embarrassing snub to Africa’s largest economy. The UAE is a key trading partner to Nigeria a the huge amount of oil trade taking place between the two producers. The Nigerian government will hope to make swift progress on this matter to prevent further losses for the Naira.
- There was nothing new to report out of Kenya this week as the downtrend in Kenyan Shilling continued on pace with the previous 2 years. The domestic market in Kenya is eagerly awaiting indicated action on fraud and foreign currency hoarding, and initiatives to incentivise much needed dollar flows into the country. KES finished the week trading at 146.80 against USD.
- The Tanzanian Shilling remained steady at 2499 against USD as the central bank and government continue to take measures to address Dollar shortages. There was no major market moving news this week, but markets will look out for indications as to whether the package of interventions is proving effective in the weeks and months ahead.
- South African Rand stayed steady a touch below 19 Rand to USD in a subdued week of data. Mining production showed a small dip, but any large movements will likely come in the coming week with South African inflation data and several major central bank monetary policy decisions upcoming.
- GBP showed further weakness last week, ending Friday’s session trading below 1.24 against the dollar for the first time since June this year. UK employment figures showed the labour market remains extremely tight with unemployment at just 4.3% and average earnings rising by more than 8.5% YoY. This was, however, teamed with a weaker than expected GDP print for July at -0.5%. In other data, we saw growth in manufacturing production but further declines in industrial production. The weakness in GBP last week were likely born out of two main issues. Firstly, the major drop off in its counterpart, the Euro, will weigh upon its geographical neighbor due to the high volume of trade between the two economic zones. Secondly, growth expectations, while better than expected, are still low for the UK economy in comparison to the US. This leaves less room for additional rate hikes if needed. Markets this week will have a keen eye on the BoE rate decision, where a 25bp hike is priced-in. More important will be the vote split and language around future hikes, which will determine the path for GBP in the coming weeks.
- The Euro fell to a six-month low this week after the ECB raised interest rates to a record high. On Thursday the Euro traded as low as 1.0632 against USD despite the 25bp rate increase to a record high of 4%. A hike to a record high in interest rates leading to a currency fall may seem paradoxical but the explanation lies in comparative economic conditions, comparative rate differentials and, most importantly of all, expectations of the future direction of interest rates. In a statement published alongside the rate decision, the ECB said that “rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to target”. Markets interpreted this as a dovish statement that the ECB is finished its rate hiking cycle and ECB futures were revised down as a result. These ECB comments come at a time of heightened anxiety around prospective contraction in the European economy and further Euro strength would likely rely on substantially weaker data from the US. Positive data out of the Eurozone last week showed stronger than expected wage growth. This was offset, however, by further declines in economic sentiment and industrial production.
- Credible sources report that China's central bank has been propping up the yuan against almost two dozen currencies over the past month, indicating that its interventions are far broader than previously known. The People's Bank of China has supported the currency against the Yen, Euro, Sterling and orther currencies since mid-August. Although the Yuan has dipped about 2% against the dollar since the end of July, it has gained about 1.2% against a trade-weighted basket of foreign currencies in the same period.?That suggests the central bank's intervention has gone much further than its stimulus announcements?last week.?
- Zambia and China agreed to encourage greater use of their own currencies in trade and investment, after a meeting in Beijing between Presidents Xi Jinping and Hakainde Hichilema. The measure will reduce currency exchange costs and exchange rate risks, the two leaders said in a joint statement on Friday. It may also curb reliance on the US dollar. This is significant for Zambia because USD is the currency in which copper is priced and the metal accounts for about 70% of Zambia’s export earnings, while China accounts for about half of global demand.
- Oil prices have spiked further, to above $90 a barrel for the first time since November 2022. Saudi Arabia and Russia continue to prop up oil prices as they stick with their cuts to production, fueling further fears of energy-driven inflation. This comes at a time of worry for the liquified natural gas industry, which is facing strikes, leading to supply issues.
We’ve talked a lot lately about interest rate comparisons between the major central banks and how this affects exchange rates, so it’s about time we showed this on a chart. Our chart this week compares the main policy interest rates of the Federal Reserve, the European Central Bank, the Bank of Japan, and the Bank of England over the past ten years. In the current rate-hiking cycle we can see that the BoE has been on a very similar trajectory to the Fed: starting slightly earlier and then moving onto a slightly less aggressive path soon after that, but really not very different. The ECB, by comparison, started later and has consistently tracked somewhat below the Fed and BoE in its level of interest rates. The BoJ is in a world of its own, dealing with a long legacy of stagnation and deflation, and has held its main policy rate slightly below zero since 2016. In the week ahead, the Fed is expected to hold steady (for the time being) while the BoE is expected to raise rates to catch up with the Fed and the ECB is expected to hold steady for an extended period at the rate of 4% it reached last week. Most strikingly, there are some signals the BoJ may break away from its negative rates policy. Going forward, this points to a stronger Dollar, Pound and Yen and a weaker Euro, all else equal.
PERFORMANCES AGAINST US DOLLAR
- Canada Housing Starts
- Canada PPI
- US NAHB Housing Market Index
- EU Inflation Rate
- Canada Inflation/ Core Inflation rate
- US Building Permits
- UK Inflation/ Core Inflation Rate
- UK PPI
- FED Interest Rate Decision
- FED Press Conference
- BoE Rate Decision
- MPC Meeting Minutes
- Canada New Housing Price Index
- Philadelphia FED Manufacturing Index
- US Existing Home Sales
- Japan Inflation/ Core Inflation Rate
- BoJ Interest Rate Decision
- UK Retail Sales
- EU HCOB Composite PMI Flash
- UK S&P Global Composite PMI Flash
- Canada Retail Sales
- US S&P Global Composite PMI Flash
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