Tag Archives: forex market

Moderate Dollar Strength

Discussion and Analysis by Charles Porter:

Labour market performance within the United States offered a short-lived boost to the US Dollar. However, the rest of the US trading session eroded the underwhelming gains made on the back of convoluted, contradictory employment data. The erosion of the value of the US dollar, for example within the Eurodollar cross, can be partially attributed to Euro re-balancing. However, the perceptibility of a Dollar reversal across all Dollar-related currency pairs suggests an endogenous Dollar retraction.

 

The headline figure of a decrease in the rate of unemployment, by 0.2%, offset weak payrolls data that saw 33,000 jobs lost in September non-farm payrolls data. The effect upon the US Dollar was temporarily positive in response to the unemployment rate. The effect was subdued, however, given the anticipated inaccuracy of hard data to economic performance following a smattering of natural disasters within US territory.

 

The performance of the US dollar against its most globally significant counterpart, the Euro, is particularly intriguing. Displayed below, the currency cross can be shown to continue its intraday trend with almost complete disregard to the US employment data. Having previously analysed the payroll and unemployment figures against the US Dollar, this article instead seeks to examine the erosion of value that has purported to make hard data redundant.

 

 

Last week’s trend of Dollar strength, is presented as a cyclical re-balancing following an unjustifiable spout of Dollar weakness amidst Euro strength. Kick started and maintained by the promise of a before-year-end interest rate hike, the re-balancing of the Euro is derived from expectations of Federal Reserve action, despite a weak rate of inflation. Moreover, whilst geopolitical risk surrounding the Dollar remains high, it is also becoming slightly dated. As investors believe they have fully priced in the enduring risk derived from the heightened tension within the Korean Peninsula, the Dollar is less constrained and can move freely.

 

Political risk and uncertainty within major reserve currencies outside of the US Dollar appear to be mounting. This changes the cost-benefit decision of holding US Dollars – one of a finite and scarce list of international reserve currencies. For example, the Euro is currently being plagued by the Catalonian conundrum. As Puigdemont faces off against Spanish Prime Minister, Mariano Rajoy, the political risk within Spain and potentially the Eurozone, forces investors to factor uncertainty within their allocation decisions, attracting their capital to other currencies. Similarly, with the fifth round of Brexit negotiations scheduled to start this week, the perseverance risk posed by Brexit is reluctant to abate.

 

Perhaps the retrenchment of US Dollar gains following a positive data release is due to market concerns about a forever-stagnant inflation rate. This would imply that following the immediate currency market euphoria that appreciated the US Dollar on the back of strong unemployment data, investors internalised stagnant inflation, in conjunction with accommodative monetary policy and low inflation, to signal the evolution of a new economic paradigm; one where interest may never rise.

 

This perhaps forebodes the later speech of permanent member of the Federal Open Market Committee, the body responsible for setting US interest rates, William Dudley. In his New York address, the President and CEO of the New York Federal Reserve Bank, highlighted that hyper low inflation is likely to be, in part, attributable to “more fundamental structural changes”. Therefore, perhaps the unexplained reversal of gains within the US dollar are down to investors’ repricing the probability of multiple 2018 interest rate hikes.

 

The Dollar has consolidated strong gains this week, trading at more comfortable levels against the Euro and the Pound, and escaping the highs in excess of 1.20 EURUSD and 1.35 GBPUSD. The sustainability of these progressions is likely to be challenged on short term, idiosyncratic bases. Therefore, the medium and long-term trend for the US Dollar appears likely to be biased in favour of a steady and considerable appreciation.

 

Catalonia and the Euro:

Discussion and Analysis by Charles Porter:

 

It is indisputable that this weekend’s referendum in Catalonia generates considerable headline risk within Europe. The instability, uncertainty, and political risk within the Spanish economy has reflected within nationally sensitive equities and indicators. However, the purchasing power of the Euro, its exchange rate vis-à-vis other currencies, appears to be largely unaffected. The question of whether this relates to a systemic insulation of the Euro, or pure insignificance of the referendum, has a particular importance to those exposed in the Euro.

 

Opening down against the Pound and the US Dollar, the Catalonian independence referendum might have been supposed to undermine Eurozone solidarity. After all, should the independence of the region be declared, at least the form of the future Spanish and potential Catalonian membership with the Union and single currency should be questioned. However, the significance of the difference before and after this weekend’s referendum was only marginal. Interestingly, the weakness within the Euro against the Pound Sterling has been reversed throughout the morning, up to 10:00 BST.

 

The result attested to following the controversial referendum generates a considerable mandate for the region’s independence. The threat of a high-productivity and nationally significant region declaring formal independence from Spain creates uncertainty both within the nation and within the region. The uncertainty should be supposed to deter investors from both the region and the nation whilst the taxation revenue and spending distribution is re-evaluated and the future legal political framework of the independent region understood.

 

This uncertainty has been reflected within Spanish markets. Notably, yields within 10-year Spanish Government bonds has increased by nearly 5% since the close of markets on Friday. The yield on bonds and general debt reflects the inverse of the price of the bond. The yield is the effective return that the bond will pay to the investor and holder of the contract, qualified by its face value. It is clear, therefore, that if the return on a bond increases, it must reflect the risk of holding the contract; the risk of no repayment. Therefore, the increase in the yield of Spanish Government bonds is telling of the political uncertainty and credit-worthiness that the referendum has installed.

 

The spill over from the referendum was not contained within the sovereign debt market. Spanish equities, particularly banking stocks, were hit by the weekend’s events. The violence and reported atmosphere within Catalonia this weekend should be considered as a strong and concerning phenomenon that has exacerbated the scare within financial markets. Overall, the impact of the referendum has damaged the value surrounding the Spanish economy.

 

So, why has the Euro not been hit that hard?

 

Well it is possible that the exchange rate priced in the political risk of the foreseen referendum better than the bond market has. However, this is highly implausible given the transparency and comparability of the free markets of bonds and flexible exchange rates, not to mention their entwinement. Therefore, instead, I suggest that the solidarity within the single currency insulates the single currency from the idiosyncrasies of national concerns.

 

Naturally, a union of 19 national currencies should not be as responsive as a national currency to an upside or downside event affecting only one nation. Sharing a currency shares exchange rate risk, de facto, without explicit design; a currency union is effectively a fixed exchange rate. Therefore, because the Catalonian risk is unlikely to transmit across borders, at least in the medium run, the deserved foreign purchasing parity of the other 18 economies should, ceteris paribus, be intact. Ultimately, currencies are a conduit for which to facilitate international trade, mobility and engagement. As such they are an excellent indicator of the integrity and strength of an economy. Therefore, the risk that the Catalonian referendum generates is mediated and diversified across the other 18 nations, thereby preserving the value of the Euro.

 

For the risk averse individual purchasing international currencies, this suggests that the volatility of the Euro to political agendas should be limited. It could be thought, and has been proven to be so, that the US Dollar contains a similar stability and value. This is why these currencies are used, or increasingly used, as reserve currencies; conduits and mediums to preserve wealth as well as facilitate trade. For those seeking exchange rate upside and downside risk, the Euro and Dollar may be unsatisfactory currencies.