Secondary effects
Despite the Federal Reserve decision last night offering momentary relief to the Dollar, a structural shift in USD remains underway. There were two themes to the Federal Reserve’s decision last night. Firstly, the Fed presented a decision to hold based upon the resilience that the US economy is showing. Secondly, Powell staged a push back against any threat of politicisation against the central bank. At face value, both of these themes should promote the value and stability of the Dollar. However, with policy and political uncertainty being the main driver of the current market theme, could these comments catalyse further backlash from the White House?
The vacuum being created by the Dollar is not being filled equally by all currencies. Let’s look at some winners and a loser of this fallout: JPY and GBP the victors, EUR the comparative loser. In the case of the latter, the selloff in the Dollar has been so sudden and severe that the Eurozone is now at risk of importing disinflation. Given the exposure of the Eurozone’s to the United States’ economy, net import costs will fall dramatically. As we wrote yesterday, with inflation hovering around target and the ECB being much later cycle in many central banks, this invites the risk of restarting a rate-cutting cycle. The same is true in Switzerland where the OIS curve shows us the potential and even expectation that negative rate policy could be introduced later this year. In the case of Switzerland however, the Franc’s attractiveness as a safehaven has outweighed this effect.
Onto the winners: JPY is an obvious one – after all, the move in the Yen based upon rumours of intervention and the snap election next week were a major catalyst for the Dollar’s own demise. But why GBP? Sterling is a risk sensitive currency these days so many might see its current bid as surprising in the face of rising volatility. The answer here must be that in contrast to the Euro and Franc, the UK’s position in its economic cycle leaves it with a higher rate of underlying inflation still. It is therefore likely a yield story that is keeping Sterling bid.
Discussion and Analysis by Charles Porter
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