New | Major currencies may see upheaval in 2016
If benign US inflationary pressures curtail the length of the Fed’s tightening cycle, next year might see the euro end up stronger against both the dollar and the yen
If monetary policy settings are the tectonic plates upon which currencies rest, there could well be upheaval in 2016 as major central banks react to the fluid global economic situation.
Although the Federal Reserve has thus far left US rates unchanged at near zero, various Fed policymakers continue to articulate the case for a possible increase in interest rates this year even after September’s disappointing US jobs data.
But as the French bank Societe Generale (SocGen) pointed out on October 7, the slide in US break-even expectations suggests “bond investors are signalling to us that they don’t believe the Fed is in control anymore” while “the Fed by contrast is brushing aside the market’s deflation concerns.”
What if the bond investors are correct? While that would not necessarily rule out a Fed rate hike from its emergency policy settings level, it would reinforce the US central bank’s consistent message that after a lift-off in interest rates any further moves would only follow a shallow trajectory.
But it would likely also mean that the duration of the Fed’s tightening cycle might be abbreviated, a possibility explored in detail in HSBC’s October Currency Outlook. “We think it will not be long after the Fed begins its tightening journey before the market is forced to ask ‘are we there yet?’” the bank said.
If “are we there yet?” arises due to the absence of inflationary pressures that would justify further increases in US interest rates, “then this allows [the Fed] to leave the US economic growth expansion unshackled. It would see the [dollar] weaken markedly as US rate expectations are pared,” HSBC wrote.
In that case, broad dollar weakness would include the greenback depreciating in value versus the euro and the Japanese yen, as well as against emerging market currencies, but neither the European Central Bank (ECB) nor the Bank of Japan (BoJ) would necessarily welcome such a move in their respective currencies when local economic prospects might still be cloudy.