1. Given the global events we have seen over the last five years, including Brexit, Covid-19 and rising inflation, what trends have you seen in the foreign exchange (FX) markets?
Tom: In the last five years it feels as if we've lurched from one crisis to the next. However, we've seen that the impact of each event often fades over time. Headlines or developments that may have previously moved markets significantly are having less of an effect. For example, the Prime Minister's latest Brexit deal was a rather significant political development, yet the value of the pound moved little in reaction.
The main focus has been on inflation and interest rates for some time now. For 18 months, inflation consistently exceeded estimates and interest rate expectations kept climbing. With the US at the forefront of the global economy, the 'dollar is king' script was followed to the letter; the dollar rallied by almost 30% to its peak in late-September 2022. Yet this strength has now almost half-unwound with what have been quite jolted moves.
The market is longing for any hint that interest rates may come down. This means weaker data point from the US economy, including slower activity, lower inflation or rising unemployment, can cause a knee-jerk reaction towards dollar weakness, which is often dramatic and then subsequently corrected swiftly.
An additional factor is the volatility around data and central bank decisions, which results in the very defensive pricing we're seeing.
2. Is the idea of a “safe haven” currency still relevant?
Ryan: Typically, fears of a global recession would see safe haven currencies such as the Japanese yen and Swiss franc rally.
However, at present the Bank of Japan is yet to raise interest rates so the yen has seen little safe haven gains. Meanwhile, the troubles with Credit Suisse have also restricted the Swiss franc's gains.
Broadly speaking, today's market feels nuanced, so it's more important than ever for us to keep our finger on the pulse.
3. Looking forward, can you give us an insight into your expectations and forecast for GBP, USD and EUR over the coming year?
Ryan: In broad terms we maintain the view that sterling and the euro will appreciate versus the dollar over the coming 12 to 18 months. Our forecast for GBP:USD is standing at $1.31 and EUR:USD at $1.18, by the end 2024.
4. What are the main factors underpinning your predictions?
Ryan: A key assumption here is that the dollar broadly weakens from its current overvaluation, not just against sterling and euro, which the latest estimates from the IMF suggest sit at 15% and 30% respectively, but against its major peers.
We believe the dollar has been supported by ‘safe haven’ demand over recent years, due to Covid-19 and the war in Ukraine. Given that we expect the global economy to recover as inflation pressures abate, this safe haven demand should unwind.
Interest rate changes will also play a key part, with the Fed having undertaken its most aggressive pace of tightening since the 1980s. As restrictive monetary policy recedes, interest rate differences should weaken the dollar.
In 2025, we expect the three major central banks, the Federal Reserve, European Central Bank and Bank of England, to have eased their policies, with rates set around 2.50%.
From a GBP:EUR perspective we envisage levels remaining around €1.12 (£0.90) and we believe this is very much a dollar story.
We would expect economic fundamentals and ultimately the path of interest rates to remain the key driver of FX sentiment.
5. Our clients sometime question the rising forecasts for GBP:USD towards $1.30. How does this relate to the slow recovery of the UK economy?
Ryan: From a sterling perspective, we would note that a number of downside UK political risks have receded. Firstly, the prospect of a second Scottish Indyref has diminished. Secondly the Windsor framework agreement over the Northern Ireland protocol looks to be have been achieved in a much more cooperative atmosphere with the EU, which could potentially open the door for further positive discussions over post Brexit arrangements. Notably, the deal has also seen the US reopen the prospect of discussions over a US/UK trade deal.
The next general election remains a risk event and while Labour look set to win on current polling numbers, the impact on FX markets may be more muted, with the current Labour party not seen as presenting the same economic risks as in previous times.
6. What do you think the new normal looks like for FX rates?
Ryan: We believe FX is going to remain sensitive to interest rate expectations.
In the post GFC years, there was very little in the way of interest rate developments: The Bank of England only managed to lift rates to 0.75% in 2018 and the European Central Bank had a negative Deposit rate from 2014 until July 2022. The Fed was an exception and tightened rates more meaningfully between 2015 and 2018.
However, there are more questions over the inflation outlook and the path of policy going forward.
7. What should clients be thinking about over the coming year with regard to their FX exposure?
Ryan: Clearly worries over the global banking system are front and centre at present. However, while there remains a high degree of uncertainty, we are of the view that the global banking system does not face a systemic banking crisis. Banks are better capitalised than in 2008/09 and in stronger liquidity positions in aggregate today.
8. Looking at all the current themes, is it still interest rates and inflation driving sentiment or is the global political tension becoming a bigger concern?
Ryan: We would expect economic fundamentals and ultimately the path of interest rates to remain the key driver of FX sentiment. That said, geopolitics is not to be ignored. The Ukrainian conflict is looking set to become a prolonged affair, while tensions between the US and China are worth bearing in mind. The next US Presidential election is also set for next year.
9. What’s been the biggest surprise for you in the FX markets over recent years?
Ryan: Of course, we would not have expected the number of shocks that have been seen in the last two years. The probability of a global pandemic, lockdowns, a major war in Eastern Europe followed by multi-decade high inflation and very aggressive monetary policy tightening was very low.
In this context, we are surprised by the enduring strength of the dollar.
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