Oliver Mangan: Ingredients in place for more sterling volatility

Oliver Mangan: Ingredients in place for more sterling volatility

We have entered a period of remarkably narrow trading ranges for most of the major currency pairs.

The notable exception has been sterling, which has been bounced around by the ebb and flow of sentiment on Brexit in recent years.

By contrast, the historically volatile dollar-yen rate has traded in a very narrow band of ¥105-114 for the past three years, a range of less than 10%.

Meanwhile, the euro-dollar rate has been confined to an even narrower corridor in the past year of $1.09-$1.15, a range of just 6%. 

This is the narrowest yearly trading range for the euro against the dollar since the launch of the single currency in 1999.

The Australian dollar has also been very range bound against the US currency in the past year, while both the Canadian and New Zealand dollars have traded in very narrow bands against the greenback since mid-2018.

The range trading has occurred despite a backdrop of elevated geopolitical risks, trade wars, a marked slowdown in the global economy and a shift in the stance of global monetary policy from tightening to easing.

This would normally be a recipe for some significant moves on foreign exchange markets.

However, currency markets have seen very little volatility in the past year or more. 

There have been just limited flows into safe-haven currencies like the yen and Swiss franc at times of heightened geo-political risks and market stress.

It may be that so-called carry trades from low to high interest rate currencies are no longer that predominant in markets, given that very low interest rates are now a feature of virtually all economies, and not just Japan and Switzerland.

Furthermore, the dollar is at a high level against a broad range of currencies, which may have made it difficult for it to make more gains in the past year.

It is also the case that the US economy slowed in 2019, with the Federal Reserve cutting rates by 75 basis points in response, much more than elsewhere. 

This may have taken some of the wind out of the sails of the strong dollar.

Nonetheless, the relative strength of the US economy and still wide interest rate differentials remain supportive of the dollar. 

The persistence of very low - or even negative interest rates - in other economies also makes it difficult for their currencies to make ground against the dollar.

This is particularly the case for the euro, with the ECB deposit rate now pitched at –0.5%, while euro swap rates are negative out the curve as far as seven years.

Indeed, it is worth noting that the euro-dollar rate has spent very little time above the $1.20 level ever since the ECB’s move to negative interest rates in 2014.

With very little change in interest rates expected in the coming year, range trading may remain the order of the day on foreign exchange markets in 2020, with the continuing notable exception of sterling.

The trade talks between the EU and UK this year are likely to prove difficult and fractious, with much uncertainty about what the final outcome will be.

All the ingredients, then, for another year of volatility for sterling.

Oliver Mangan is chief economist at AIB

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