Financial markets have continued to encounter a more volatile trading environment, writes John Fahey.
The declines in February were prompted by investors getting concerned that the improving global economy could result in increased inflationary pressures. This could result in global monetary policy being tightened at a quicker pace than previously anticipated.
In recent weeks, the latest bout of risk aversion has been triggered by growing concerns about a possible global trade war after the US announced tariffs on a range of imports from China.
At the same time, amid the more nervy backdrop, the flight to safety out of equity markets has supported bond markets. We expect this will prove a temporary rally and the uptrend in yields will reassert itself over the coming months as global monetary policy continues to be tightened. The effect on currency markets is much less discernible. The euro has been quite range bound against the dollar, yen and sterling during March and this has continued into the start of April.
Currency markets are struggling for direction. There have been plenty of events for currency markets to absorb recently, including the aforementioned declines in equity markets, trade war risks, more hawkish central banks, and Brexit.
However, major currencies have remained largely unresponsive to these events. Nevertheless, we expect trends in currency trading over the last 12 months will reassert themselves as the year progresses.
Our view remains that the dollar has entered a long-term weakening trend. We expect the dollar’s rally over the period from mid-2014 to the end of 2016 will continue to unwind as other central banks join the Federal Reserve in tightening policy on improving global growth.
From a euro perspective, the currency is still at a low level against the dollar at around $1.23. This suggests that the euro-dollar rate has considerable further upside potential. We expect it to test the $1.30 level before the year is out. Sterling also has upside potential if progress continues to be made in the Brexit negotiations.
John Fahey is senior economist at AIB