The Sentiment Drivers for the Major Currencies Going into 2020
US Dollar Analysis
Although the Federal Reserve has slashed interest rates three times in 2019. The dollar remained fairly firm against many of the major currencies due to the political and economic performance of many of the other currencies that made the dollar still a more attractive currency asset to buy in foreign exchange.
- The Fed’s interest rate is still the highest out of all of the G-10 currencies, making the dollar still an asset rather than a liability when trading exchange rates.
- The Euro, Australian & New Zealand Dollar have all weakened against the dollar as poor economic data, interest rate cuts and political uncertainty has meant none of these currencies have been able to strengthen against the dollar in 2019.
- The Canadian Dollar has managed to strengthen against the dollar as the Bank of Canada has held off from cutting interest rates this year.
- The Japanese Yen and Swiss Franc have also appreciated against the dollar as the interest rate differential between the United States and the respective countries has narrowed, mainly because interest rates in Japan and Switzerland are so low, they can’t go any lower from here.
- The pound has gained against the dollar because of the risk of a no-deal Brexit being removed, alongside the pound being so undervalued since 2016 that it’s still not trading at its fair value.
Moving forward, US-China trade talks will have a big impact on whether the Fed decides to cut interest rates further in 2020. The Fed has been cutting rates as an insurance policy to make sure the economy continues to grow as the global economy has slowed since the trade war started in 2018. Therefore, the outcome of trade talks will affect the dollar’s performance due to the dollars’ safe-haven status
If talks breakdown and the US is still growing at a faster pace than many of the major economies, the dollar will strengthen as investors sell off global stocks to buy US treasury bonds which are sold in US Dollars. Meaning most currencies like the euro will be sold to buy dollars when investors in places like Europe dump European stocks to buy Bonds in the US.
If trade talks go well and the outlook for global economies improve, markets will sell off US dollars and go back into riskier currencies. Interest rate expectations from the major central banks will also play a key role in moving forward.
British Pound Analysis
The pound has strengthened in 2019 as the risk of a no-deal Brexit has been removed since Boris Johnson was forced to request an extension to the Brexit deadline until January 2020, which the European’s grudgingly accepted.
Therefore, investors have been slashing back investment into the UK and the currency has remained under pressure because of the uncertainty since 2016. We are now in a position where the risk of a no-deal Brexit has been priced out of the currency, hence why it has strengthened in the past month.
However, with parliament not passing the deal the UK and EU made last month into law to meet the October 31st deadline, plus parliament’s want to amend parts of the deal. We now face a General election on December 12th. The conservatives have pushed for the election to ensure they can win enough MP seats in the parliament to form a majority government that can pass the Brexit Deal without being impeded by opposition parties.
- A conservative majority win is seen as positive because the likelihood of the deal going through is drastically improved.
- A Labour win could also be seen as positive as Labour has offered a second referendum on Brexit.
However, markets are unsure as to who will win the election. Both of the major Parties are in internal chaos because of infighting over the split opinion in the right direction to take the UK out of the EU. Therefore, either party will likely have to form a coalition government with another party to ensure they can be in power.
This is where the risk of the Brexit party comes into play. The Conservative party is ahead in the polls to win, but if they fail to win enough seats in the houses of parliament to form a majority government, they will have to form a coalition government with another party. This will likely be the Brexit Party that would demand that to help the conservatives to win power in government, the conservatives must cut ties with the EU. That makes markets at the moment hesitant towards buying the pound. Until a clear path is visible, the pound is likely to continue to trade in a rangebound motion.
The Euro has remained under severe selling pressure in 2019 as the European economy has continuously contracted towards a recession.
With Germany, the European economic powerhouse slowing as its export-driven economy has been hit hard by the global slowdown in trade, mainly caused by the US-China trade war, the ECB (European Central Bank) has been forced to re-introduce monetary stimulus in an attempt to boost spending, investment and inflation back towards the ECB’s 2% target and help economic growth recover.
The excess money pump into the economy devalues the purchasing power of existing Euro’s in circulation, due to the supply and demand equation and expectations of inflation in the future. Future moves in the Euro will come from economic data either being more positive or remaining negative.
- A string of positive data points would improve the forecasted outlook for the European economy. This would allow the ECB to remove its monetary stimulus package currently being implemented. The value of the Euro would be lifted as the supply of the currency is removed.
- If trade talks between the US and China also improve, this could help export-driven countries like Germany recover and could help the Euro appreciate as the positive sentiment towards trade improves.
- Negative data points will force the ECB to pump even more money into the system, devaluing the Euro in the process.
Japanese Yen Analysis
The Japanese Yen’s performance remains completely dominated by risk-on / risk-off sentiment in stocks and commodity markets or down to the performance of other currencies based on their own economic and political circumstances.
With Japan experiencing extremely low inflation, currently at 0.20%, which is 1.8% away from the Bank of Japan’s 2% target. Interest rates will remain in negative territory for the foreseeable future. This means the Yen remains a funding currency that investors use to buy other currencies with higher interest rates to earn a positive carry from the difference.
Until markets see Japan’s inflation rise towards 2%, the Yen’s performance will never be down to positive economic data from Japan, but more down to the performance of other currencies.
For example, The Yen has strengthened against the Australian and New Zealand dollar in 2018 / 2019, but only because of the weak performance of both currencies since the US-China trade war started in 2018 and both central banks in Australia and New Zealand started cutting interest rates in response.
If stocks and commodity prices fall in value, the safe-haven Yen appreciates due to investors buying Japanese Government bonds that are sold in Japanese Yen, meaning when investors dump stocks in countries like Europe, they sell their euro’s in exchange to buy the Japanese Yen in order to buy Japanese Government bonds, increasing the demand in the Yen in the EUR/JPY exchange rate and pushing the currency pair lower.
This is why the Yen appreciates against pretty much all currencies when there is a risk of sentimental stocks and commodity prices. Japan is seen as a safe place to invest when stock markets are falling because Japan has one of the world’s largest trade surpluses, meaning more money comes into Japan from Export sales then money goes out through import purchases. This means investors are extremely confident that when they purchase Japanese government bonds the Japanese government will always repay their debt obligations because of their ability to raise revenue from the excess supply of cash reserves in the economy.
So, when stocks fall, investors sell off stocks, buy short term Japanese government bonds that they can and sell easily, wait until stocks start to rise again and then sell the bonds to move back into global stocks.
This explains why the Yen appreciates or depreciates when investors want to take a risk in stocks or take the risk-off and come out of stocks and their portfolios. Hence the term ‘Risk on / Risk off’ market sentiment.
Canadian Dollar Analysis
The Canadian Dollars’ performance remains based on market expectations for what the Bank of Canada will do next with its monetary policy outlook and decisions with interest rates. The Bank of Canada said at its recent interest rate policy decision meeting that the economy is performing below its full potential because of the effect of the global slowdown.
The Bank is keeping rates on hold at the moment as inflation is close to the bank’s 2% target but will be monitoring the developments of the global economy to make a decision on what to do with interest rates, should any further deterioration in global growth threaten Canada’s 2% inflation target from being achieved.
The Canadian Dollar has been stronger against nearly all the major currencies as the Canadian economy has been able to remain robust during the global slowdown, meaning the central bank has been able to keep interest rates on hold whilst other central banks have been cutting rates.
- If the Bank of Canada keeps rates on hold, the currency will remain supported.
- If the Bank of Canada cuts rates we would see some weakness in the currency, but only against currencies that are not cutting rates at the same time.
New Zealand Dollar Analysis
The primary driver for the New Zealand Dollar remains New Zealand’s monetary policy outlook with strong expectations for further rate cuts from the RBNZ (Reserve Bank of New Zealand) in the near future. Therefore, the fundamental outlook for the New Zealand Dollar remains to the downside as more weakness is expected if rate cuts are implemented.
In the short term, it is worth noting that risk-on sentiment caused by US-China trade headlines being more positive can cause the currency to rise in value if markets push back expectations for further rate cuts from the RBNZ.
Markets are pricing in a 54% probability of a rate cut on November 13th. Economic data out of New Zealand and the US-China trade headlines will be key for the New Zealand Dollar moving forward.
Australian Dollar Analysis
The Australian Dollar has found some support recently as expectations for the reserve bank of Australia to cut interest rates have been pushed back into 2020. This has been mainly due to the progress being made between the US and China towards signing a phase one trade deal. Australia’s economy is extremely exposed to any slowdown in global growth as the economy is reliant on export sales to boost investment, jobs, inflation, and growth.
Australia’s economy is strongly linked to the performance of the Chinese economy as it purchases a large majority of Australia’s commodity exports that’s a key income source for the country. Since the trade war started commodity prices have been falling and the Australian central bank has been forced to cut interest rates to manipulate the value of the currency lower to keep its export sales at a competitive price.
- Any progress in the US-China trade talks and a positive turnaround in global growth will support the currency.
- If trade talks breakdown and the world economy experiences a bigger slowdown, especially China, expect the RBA to cut rates and the Australian Dollar to weaken.
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