Oliver Mangan: Feeling of calm persists on currency markets for now
It has been generally confined to a $1.04-$1.16 trading band since early 2015. One of the reasons for this is that the expected series of rate hikes by the US Federal Reserve over the course of 2015/16 did not materialise.
Meanwhile, the ECB has pursued a very loose monetary stance in the past two years. As a result, with both US and eurozone rates staying very low, the EUR/USD pair has been quite range bound.
The dollar, though, did move higher against the euro and other currencies in the closing months of last year. Growing expectations that the Fed would implement a number of rate hikes boosted the US currency.
Furthermore, Donald Trump’s unexpected victory in November’s Presidential election also saw markets price in a more aggressive path for Fed rate hikes over the next three years.
The dollar hit 14-year highs on a trade-weighted basis in late 2016/early 2017.
This also saw the euro drop to 14-year lows against the dollar below $1.04 at the turn of the year, having traded in a $1.12-$1.15 range earlier in the year.
The euro, though, has regained some ground against the dollar in the opening months of this year, rising above $1.08 at one stage, despite a further rate hike from the Fed in March.
A more significant change, though, has been in regard to expectations around ECB policy, with markets now anticipating that the ECB could begin moving rates higher next year.
Meanwhile in the US, markets are growing somewhat impatient with the slowness of the Trump administration in getting started on implementing its planned expansionary fiscal policies.
Indeed, there are doubts about how much of his fiscal agenda resident Trump will be able to implement. This has not helped the dollar.
Overall though, the fact that the Fed appears to have moved onto a steady rate tightening path should help underpin the US currency.
However, it would seem that markets will need to see progress on the implementation of President Trump’s fiscal agenda, as well as further hikes in US interest rates, for the dollar rally to be re-ignited.
Meanwhile, sterling has been more stable since the autumn.
It has managed to regain some ground against the euro, largely trading in an 84p-88p range since early November.
The UK economy has held up much better than expected since the Brexit referendum vote last June and growth forecasts for 2017/18 have been revised upwards.
UK headline inflation has risen sharply to 2.3% and could hit 3%.
With the British economy holding up and inflation also on the rise, the markets now think that the Bank of England could hike UK rates by the end of next year, quite a turnaround from late last summer when further policy easing was expected.
The UK also seems increasingly confident that it can secure a favourable exit deal with the EU.
The Article 50 letter was quite conciliatory in tone, while various EU leaders have also expressed the hope that a deal can be done between the EU and the UK.
All this has helped create a more positive backdrop for sterling.
The UK currency could remain quite stable for much of this year, given that there is unlikely to be any major market moving newsflow from the Brexit negotiations for some time.
Downside risks, though, remain for the UK currency as the exit negotiations are still likely to prove difficult, especially as they come to a head next year, when they get to trade and what transition arrangements might be put in place when the UK leaves the EU.
