World’s top currencies no longer one-way bets
Divergences in monetary policy are no longer determining the direction of currencies to the extent that they were several months ago
At the beginning of this year, the world’s three most-traded currencies - the dollar, the euro and the yen - were still being driven by the divergence in global monetary policies.
In the first 10 weeks of this year, the dollar strengthened a further 14 per cent against the euro as market positioning favoured a stronger greenback and a weaker single currency due to the confluence of an anticipated rise in US interest rates later this year and the launch of an aggressive quantitative easing (QE) programme by the European Central Bank (ECB) in March.
Meanwhile, the yen, having fallen a further 17 per cent against the dollar in the second-half of last year in response to the QE programme undertaken by the Bank of Japan (BoJ), lost an additional 4.5 per cent between mid-January and mid-March.
Since then, however, all three currencies have become more volatile, partly because of the halt to the dollar’s bull run.
Since mid-March, the euro has risen nearly 6 per cent against the dollar and is set to enjoy its best quarterly performance against the greenback since the first quarter of 2011. On Monday, positioning data from the US Commodity Futures Trading Commission (CFTC) showed that net short positions - or bets against a stronger euro - were at their lowest since last July.
While the euro’s resurgence is partly attributable to the weakness of the dollar stemming from this year’s unexpectedly lacklustre US economic data (which has led bond investors to push back the timing of a rise in US interest rates), it is also driven by signs of a stronger European recovery and the resilience of the euro to the festering Greek crisis.
On Tuesday, preliminary data from Markit, the financial research company, showed that eurozone economic growth hit a four-year high in June. Even France’s weak manufacturing sector is no longer contracting after 12 straight months of decline.
In Japan, meanwhile, the dramatic decline of the yen against the dollar since the end of 2012 (a nearly 60 per cent devaluation since September 2012), has become a sensitive political issue for the government of premier Shinzo Abe. Higher import prices have hurt households and small businesses at a time when domestic demand in Japan remains weak.
Even the BoJ, which has favoured a weak yen to help it meet its 2 per cent inflation target, believes the currency’s decline may have gone too far. Earlier this month, Haruhiko Kuroda, the BoJ’s governor, said there was little scope for the yen to fall further, casting doubt on whether the central bank will provide further stimulus. Indeed the yen has been much more stable against the dollar this year and has strengthened 1.3 per cent since June 5.
Over the past three months, all three currencies have ceased to be the one-way bets foreseen by traders and strategists at the beginning of 2015.
Divergences in monetary policy are no longer determining the direction of currencies to the extent that they were several months ago.
This is partly because central banks themselves have become a source of volatility for markets. Mario Draghi, the president of the ECB, admitted as much on June 3 when he said government bond investors had to “get used” to volatility given the exceptionally low yields on sovereign debt.
Stronger-than-expected economic data in the eurozone and, to a lesser extent, Japan, coupled with a weaker US economy, are challenging the underpinnings of the policy divergence theme.
Not only is the bull case for the dollar less clear-cut than it was at the beginning of this year, the bear case for the euro is not as evident as it once was. According to Rabobank, the Greek crisis has, paradoxically, underscored the euro’s role as a quasi-safe haven currency due to the eurozone’s large current account surplus, resulting in a repatriation of European investors’ overseas assets.
Still, there is significant scope for the dollar to resume its ascent as investors focus on the likelihood of a rise in US interest rates in September (still seen as the most probable month for “lift-off”).
The euro fell 1.6 per cent against the dollar on Tuesday partly because of comments by a US Federal Reserve policymaker claiming the central bank may hike rates twice this year.
However another reason why the euro declined is because investors are using the low-yielding euro as a funding currency to buy higher-yielding assets on the back of news that a short-term deal between Greece and its creditors is now more likely.
Seen in this light, a weaker euro is a sign of market confidence. This is confirmation, if any were needed, that currency movements are difficult to fathom.
Nicholas Spiro is managing director of Spiro Sovereign Strategy