It is the dollar, and really only the dollar, that investors seem happy to use as a prime asset within currency markets at the moment. Other G10 currencies are all being hit hard right now by stronger perceived risks in their respective economies. The most toxic currently are concerns over the inflation outlook; that takes care of Norwegian krone, Swedish kroner and the euro.
The Swiss franc is also prone to deflation and investors also seem happy to not stand in the way of a Swiss National Bank that wants a weaker currency. The central banks of Australia, New Zealand and Canada are all in the same boat here – actively talking down their respective dollars in the past few months. That leaves the Japanese yen and the British pound.
Thanks to the actions of the Bank of Japan last Friday that saw a surprise increase in the monetary base – adding money into the Japanese financial system – by Y10trn and a possible pushing out of the date by which the country’s 2% inflation target must be hit, we can take the yen off the table. Holding a currency with no yield and down 3.6% in the past month vs the USD is an investment strategy ripped from Brewster’s Millions.
The pound is doing well on economic grounds but it is the political aspect that gives us cause for concern. As we have spoken of before, the prospect of a British exit or ‘Brexit’ from the European Union cannot be discounted away from sterling at the moment. Granted, little will happen between now and the General Election in May of next year, however the shift in language and engagement could easily move the immigration debate above that of the economy; the traditional ‘most-important’ matter in elections.
And so we’re left with the US dollar. Obviously that is not to say that the US dollar will carry on higher regardless of economic circumstance; the Federal Reserve made sure to emphasize at its October meeting that policy remains very data-dependent. If we whiff on payrolls this Friday then the USD will reverse.
Last week’s Fed meeting allowed markets to run its hopes of Fed funds rate rises closer to the present. The prospects of a hike by July of next year have increased from 40.4% on Tuesday to 51.8%. The expected date of the first hike has been moved in by one meeting as a result of last night’s statement with the second rate hike moved in by two meetings. So much for the Federal Reserve apparently being “behind the curve”.
While there is a lot of talk and conjecture around the Mid-term elections, I believe there will be little market impact from the vote. It is largely priced in that Republicans will win the House and re-take the Senate but will not be quite strong enough to pull in the ten vote majority they need to prevent filibustering. This leaves Obama as a lame-duck President. Republicans now control the table when pressures on the Budget and the ongoing use of continuing resolutions come up to deadline in the middle of December. The markets hate fiscal policy battles and therefore represents a real risk to the USD into the end of the year.