New | Flip-flopping Fed a challenge to monetary divergence trade
The Fed’s credibility has suffered significantly
As recently as the first quarter of this year, the task facing the world’s foreign exchange traders was a fairly straightforward one.
With the US Federal Reserve expected to begin raising interest rates sometime in the middle of this year and the European Central Bank (ECB) heading in the opposite direction by finally launching a programme of full-blown quantitative easing (QE), the so-called “monetary divergence trade” - buying the dollar and selling the euro - seemed like a one-way bet.
Between March 2014 and March 2015, the greenback surged 25 per cent against Europe’s single currency - and by a further 18 per cent against the yen partly because of the even more aggressive QE programme being undertaken by the Bank of Japan (BOJ) - as the divide between the two leading central banks in the developed world became more pronounced in the minds of investors.
Then, all of a sudden, the trade began to unravel.
The dollar weakened 8.6 per cent against the euro between mid-March and mid-May and has since been much more volatile, prompting HSBC to call an end to the dollar’s bull run and making large directional bets in foreign exchange markets - such as a strong dollar and further weakness in emerging market (EM) currencies - much more difficult.
