Global FX and Currency – Mid-Year Review

Across the world, there is one trend emerging strongly. This is the trend of  political and economic decision-making starting to make less sense than ever before.  We thought it would interesting to evaluate the impact that has had on the foreign exchange and currency markets. From a macro-economic perspective, the major theme in the first half of 2017 has been the surprising decline of the trade-weighted U.S. Dollar (USD), which in turn has elevated several global currencies. Other overarching developments have stemmed from European election results, low global commodity prices, and policy shifts in Asian economies.

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North America

After a bullish start to the Trump Presidency last November, U.S. markets have retreated in recent months, following soft economic data[1] and a prolonged stretch of legislative gridlock in Washington. The latter has tempered expectations of the administration to successfully pass market-sensitive bills, particularly tax and infrastructure reform.[2] With key policy issues losing traction – as tensions with North Korea take focus – in addition to poor growth data, the Fed will be hard-pressed to accelerate rate increases moving forward. And with easy monetary policy, downward pressure on the USD will persist. Indeed, the USD sank against a basket of major currencies by about 5-8% over the past 6 months.[3]

An offshoot of Washington’s inability to pass through meaningful legislation has been the dramatic rise of the Mexican Peso (MPX), which has emerged as the region’s top performer. As protectionist pledges from the Trump administration become a distant memory, NAFTA agreements remain in-tact.[4] This is not to mention the progress that has been made by Banxico in soundly managing FX reserves.[5] With the MPX/USD already coming off a 15-month high in July– of 17.45 per USD – The IMF has stoked bets of a further rally, adding that the Peso is actually undervalued relative to the USD, as markets have priced in protectionist risk that hasn’t materialized. [6] [7]

The Greenback’s decline coincided with an even more surprising event north of the border – the decision from the Bank of Canada to raise the policy interest rate for the first time in 7 years. The hike comes at a curious time considering the dearth of reflation in Canada. The low interest rate environment that has been the norm for most of the 2000’s – mainly to combat weak commodity prices and facilitate low borrowing costs – has done little to spur the economy out of lethargy, so a path of monetary tightening is unlikely. In addition to pressure from crude oil’s continuous slump, there are two unfavourable scenarios that would only be compounded by higher interest rates: unsustainably high levels of federal and provincial debt, and the prospect of further foreign investment in search of yield. Investment from wealthy Asian investors in particular has already been pinpointed as the main contributor to overheated housing markets. The pace of further rate hikes will thus need to be moderated, and the CAD/USD doesn’t look likely to sustain a bullish run.

Central Europe and Britain

In Europe, FX swings were tied to political developments. On the continent, the wave of populist momentum leading up to key elections was stymied by results in France and the Netherlands. The ascent of Jean Macron’s En Marche! and Mark Rutte’s VVD parties, which had both campaigned on centrist platforms, allayed political fears at least in the short-term, giving the ECB further confidence to proceed with its tapering of monetary stimulus. Mario Draghi certainly has done his part to guide financial markets upward, citing strong reflationary levels and Eurozone growth as impetus for a proposed QE tightening in September. [8],[9] These upbeat developments have driven Euro strength, and the EUR/USD is trading at higher levels not seen since early 2015 (EUR/USD breached a resistance level of 1.14 at the end of June and has risen to 1.18 where it hovers today; EUR/USD last traded at 1.14 in early February 2015).[10]

The British election result struck a much more sombre tone for markets, after Theresa May’s political gamble failed and the Conservatives relinquished their Parliament majority. The result was added uncertainty surrounding the new governments’ capacity to control talks to leave the EU, and the GBP thudded against a basket of currencies in early June.[11] There was further surprise on the downside following a release of weak inflation data in July and subpar GDP growth in June – a meagre 0.3%.[12] However, British economic data for Q2 was mixed overall. Strong jobs and housing reports, in addition to increasingly favourable business conditions, offered some reprieve for the Sterling, prompting BoE Governor Mark Carney to take a hawkish line on monetary tightening.[13] While the GBP continues to slide against the EUR, the GBP/USD has actually soared to a 10-month high, as Brexit jitters have apparently been overshadowed by the disorder in Washington.[14]

Asia Pacific – Emerging Markets and Japan

While Asian currencies have climbed on the back of USD weakness, the theme in the region has been the remarkable resilience of financial markets in the face of geopolitical tensions. Despite persistent North Korean belligerence, neighbouring markets have shrugged off any pressure.

Leading Asia Pacific is the South Korean Won (KRW), up 7.8% against the USD (from January to July).[15] Nonetheless, the KRW Won has come off a volatile Q2. With financials and IT stocks extending gains, the domestic KOSPI index set a new record in mid-June, but two weeks later institutional investors precipitated a sell-off on risk concern, and equity markets skidded.[16] Franklin Templeton in particular, cut sizeable positions in Korean treasuries, causing their yields to jump, a move that raised concerns over fund outflows.[17] However, new president Moon Jae-In has promised to shake up the influence of the chaebol – the conglomerates who have long controlled the economy – which would be a boon for foreign investment, raising speculation of further appreciation in the KRW.[18]

The Thai Baht has been another strong performer of late; recent gains against the USD have come without derailing exports, according to the Bank of Thailand, which does not fix the currency as China does, but will intervene to manage excessive movements.[19] An export-oriented market, further appreciation of the Baht will need to be weighed against economic targets. Elsewhere, the Malaysian Ringgit and Singapore Won have each enjoyed a boost from encouraging data, on industrial production and retail sales respectively.[20]

The Japanese Yen (JPY), however, continues to buck multiple trends. While most of its G10 peers have adopted monetary tightening, Japanese policymakers remain staunchly committed to negative rates. As FX traders sense that a rate hike is unlikely this year, their consensus is that going long any G10 currency against the JPY is a winning bet.[21] Over the past 12 months, the JPY has sunk by double-digit percentage points against all G10 peer currencies, and July saw the highest levels of shorting activity on the JPY since January.[22]

BRIC Nations

China and India, while buoyed by the proceedings (or lack thereof) across the Pacific, have been driven by domestic advancements.

The upward trajectory of the Chinese Yuan (CNY) has been fully backed by the People’s Bank of China, which fixed the daily Yuan midpoint – of a narrow band set to control the currency – at 6.7744 per dollar on June 30th, the strongest level since November 7, 2016.[23] [24] State banks were also active in a late June rally, dumping the USD en masse to prop up the CNY.[25] The reversal in policy from Chinese authorities comes following concerns from last year of rapid devaluation and significant capital outflows. Q2 data confirms that these outflows have since eased, while FX reserves have expanded.[26]

In India, the bull market has charged forward frenetically, as foreign investors pour in funds to capture higher risk-free rates of return, which have arisen from monetary reforms, political stability and the likelihood of further rate cuts.[27] These conditions make India’s debt assets particularly appealing; among debt markets in Asia, India offers the highest yield after Indonesia. The INR, which has already rallied 6% over the past 6 months,[28] is poised to further appreciate according to a consensus of investment bank forecasts.[29]

In Brazil, the business climate was expected to strengthen under the new administration, but corruption allegations have followed new President Temer. Deteriorating political stability, coupled with low commodity prices, has sent the Brazilian Real (BRZ) into a tumble heading into the second half of 2017.[30] The BRZ has fallen against the USD on the year. However, non-commodity exports have offered signs of a recovery.

The Russian Ruble, another victim of low commodity prices, pared gains from earlier in the year, after a disappointing stretch in Q2. The economy has felt the full force of increased sanctions from Western governments – as penance for alleged interference in the U.S. Presidential elections – and continues to struggle under weak exports and high inflation.[31] With substantial capital outflows, the Ruble is under severe duress and looks unlikely to recover anytime soon.

The macroeconomic narrative mid-way through 2017 has centred on the regression of the USD, as legislative impasse in Washington hampers economic progress. At present, trade-dependent emerging markets have been the prime beneficiaries, including Mexico, Thailand, Malaysia and Singapore. However, whether their currencies can sustain their bullish streaks during a Greenback revival remains to be seen. Such a scenario would portend some separation between those currencies backed by strong, organic growth in their respective economies, and those that are simply over-reliant on trade. This is not the case in Europe, where robust growth in the Eurozone has driven the EUR upward, nor in Britain, where encouraging data has kept the GBP afloat. Commodity-driven markets, Canada, Brazil and Russia, will continue to struggle under weak crude prices and domestic headwinds. The CNY and INR however, lead the pack globally; the KRW is not far behind, but will be tested as conflicts with North Korea escalate.

 


 

[1] “Macro FX Trading Q2 2017 Commentary.” Saxo Group, 13 July 2017, www.home.saxo/campaigns/global-campaign/saxoselect-trading-strategies-commentaries/2017-q2/macro-fx-trading-q2-2017-commentary.
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[2] Mahmudova, Anora. “Dollar Bulls Have a Lot to Worry about in Second Half of 2017.” MarketWatch, 3 July 2017, www.marketwatch.com/story/dollar-bulls-have-a-lot-to-worry-about-in-second-half-of-2017-2017-06-29.
[3] ibid
[4] “Mexican Peso Poised for Best Week in Nearly Six Months.” Financial Times, Financial Times, 14 July 2017, www.ft.com/content/26e407bf-2eed-34ae-a3c2-0ec47f40edb1.
[5] ibid
[6] Yuk, Pan Kwan. “Mexico Notches 16th Straight Quarter of Growth despite Trump Fears.” Financial Times, 31 July 2017, www.ft.com/content/0587bdf7-c5d1-3cf0-9a31-1c6115aca668.
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[7] “EMERGING MARKETS-Brazil Real Firms on Slowdown in U.S. Wage Growth.” Reuters, Thomson Reuters, 28 July 2017, www.reuters.com/article/emerging-markets-latam-idUSL1N1KJ144.
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[8] Watts, William. “Why Mario Draghi Can’t Back down from ECB Taper Hints.” MarketWatch, 20 July 2017, www.marketwatch.com/story/why-mario-draghi-cant-back-down-from-ecb-taper-hints-2017-07-19.
[9] Gilchrist, Karen. “Euro Surges against Dollar as Draghi Says QE Tightening Talks Will Start in September.” CNBC, CNBC, 20 July 2017, www.cnbc.com/2017/07/20/euro-surges-as-draghi-comments-on-ecb-asset-purchases.html.
[10] “EURUSD=X : Summary for EUR/USD.” Yahoo! Finance, Yahoo!, 12 Aug. 2017, finance.yahoo.com/quote/EURUSD%3DX?p=EURUSD%3DX.
[11] “British Pound Dives as U.K. Enters New Period of Political Uncertainty.” CBCnews, CBC/Radio Canada, 9 June 2017, www.cbc.ca/news/business/united-kingdom-election-pound-1.4153368.
[12] Khan, Mehreen. “UK GDP Growth Edges up to 0.3% in Q2.” Financial Times, 26 July 2017, www.ft.com/content/84026c88-c277-36f2-b682-0a31359957ae.
[13] Razaqzada, Fawad. “GBP in Focus as Carney Hints at Possible BoE Rate Hike.” FXStreet, 28 June 2017, www.fxstreet.com/analysis/gbp-in-focus-as-carney-hints-at-possible-boe-rate-hike-201706281804.
[14] Andrews, Matthew. “Pound v US Dollar: GBP Rockets to 10-Month High against USD.” Express.co.uk, Express.co.uk, 1 Aug. 2017, www.express.co.uk/finance/city/835541/Pound-dollar-exchange-market-pound-rates.
[15] Karunungan, Lilian. “Asia’s Top-Performing Currency Is Missile-Proof.” Bloomberg.com, Bloomberg, 18 July 2017, www.bloomberg.com/news/articles/2017-07-18/low-yield-is-no-problem-for-south-korean-won-defying-the-bears.
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[16] “Seoul: Stocks Cap off 7th Straight Month of Gains; Won Hits 11-Week Low.” The Business Times, 30 June 2017, www.businesstimes.com.sg/stocks/seoul-stocks-cap-off-7th-straight-month-of-gains-won-hits-11-week-low.
[17] ibid
[18] Karunungan, Lilian. “Asia’s Top-Performing Currency Is Missile-Proof.” Bloomberg.com, Bloomberg, 18 July 2017, www.bloomberg.com/news/articles/2017-07-18/low-yield-is-no-problem-for-south-korean-won-defying-the-bears.
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[19] Nation, The. “’Stronger Baht Won’t Hurt Thai Exports as Demand Boosted by Global Recovery’.” The Nation, 30 July 2017, www.nationmultimedia.com/detail/Economy/30322269.
[20] “EM ASIA FX-Asian Currencies Push Higher as Trump Woes Weigh on Dollar.” Reuters, Thomson Reuters, 12 July 2017, www.reuters.com/article/asia-forex-emerging-idUSL4N1K3237.
[21] Blitz, Roger. “Plenty of reasons for traders to bet against the Japanese yen.” Financial Times, 11 July 2017, www.ft.com/content/d6687516-6636-11e7-8526-7b38dcaef614.
[22] ibid
[23] Cnbc. “China C.bank Fixes Yuan Midpoint at Strongest Level in Nearly 8 Months.” CNBC, CNBC, 29 June 2017, www.cnbc.com/2017/06/29/reuters-america-china-c-bank-fixes-yuan-midpoint-at-strongest-level-in-nearly-8-months.html.
[24] “China’s Yuan Makes Late Surge on State Banks’ Support.” Reuters, Thomson Reuters, 27 June 2017, www.reuters.com/article/uk-china-yuan-idUSKBN19I0ZV.
[25] ibid
[26] ibid
[27] Goyal, Kartik. “RBI Cut Seen Adding Fuel to Rupee Rally as Two-Year High Reached.” Bloomberg.com, Bloomberg, 3 Aug. 2017, www.bloomberg.com/news/articles/2017-08-03/rbi-cut-seen-adding-fuel-to-rupee-rally-as-two-year-high-reached.
[28] Ninan, Oommen A. “Stronger Rupee Likely to Hit Export Competitiveness.” The Hindu, 12 Aug. 2017, www.thehindu.com/business/Economy/stronger-rupee-likely-to-hit-export-competitiveness/article19481892.ece.
[29] Goyal, Kartik. “RBI Cut Seen Adding Fuel to Rupee Rally as Two-Year High Reached.” Bloomberg.com, Bloomberg, 3 Aug. 2017, www.bloomberg.com/news/articles/2017-08-03/rbi-cut-seen-adding-fuel-to-rupee-rally-as-two-year-high-reached.
[30] Sadler, Mary. “Why Brazil’s Exports Stayed Steady in June.” Why Brazil’s Exports Stayed Steady in June – Market Realist, 18 July 2017, marketrealist.com/2017/07/why-brazils-exports-stayed-steady-in-june/.
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[31] Schoen, John W. “US Sanctions Have Taken a Big Bite out of Russia’s Economy.” CNBC, CNBC, 25 July 2017, www.cnbc.com/2017/07/25/us-sanctions-have-taken-a-big-bite-out-of-russias-economy.html.
Kabir Vassanji

Kabir Vassanji

Junior Editor at InPRA
Kabir Vassanji graduated from McGill University in Montreal, Canada, with a degree in Finance and International Business in 2015. He has interned in the fields of wealth management and capital markets, and now works at an investment bank. His areas of interest include finance, economics, technology, and foreign affairs. Particularly of interest is the intersection of finance and macro-economic policy, within his home country Canada, as well as in emerging markets. In exploring these topics with InPRA, Kabir hopes to enhance his writing and research skills to complement his quantitative background.
Kabir Vassanji

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