USD, Yen and GBP

  • The USD should strengthen into 2016/2017 with rate hikes.
  • Global growth significant factor in currency markets.
  • Weak global growth may hinder rate hikes and stagnate USD.
  • Yen a safe haven due to large trade surplus and market psychology.
  • GBP will be volatile in build-up to BREXIT. Markets currently see a ‘leave’ vote as negative, following the positive reaction to Cameron’s deal with Europe (GDP/USD +1.025%).

In December 2015 the Fed raised interest rates from 0-25bps to 25-50bps, off the back of this interest rate rise the USD should in be for an exciting year.

Further rate rises are anticipated and the strength of the US economy vs. the world economy is expected to continue to increase. Within the currency markets there have also been some interesting developments with the Yen. It has strengthened 6% against the USD since Feb 1st 2016 . This is shown in Figure 1, leading to a natural question over its position as a safe haven, considering its low interest rate environment and poor domestic growth. The GBP will see volatility in the build up to the BREXIT referendum on the 23rd June 2016 and is expected to react positively to the UK staying in the Eurozone.

Figure 1. USD/YEN
Figure 1. USD/YEN

The WorldBank forecasts US GDP growth to average around 2.5% a year for the next 3 years, which is marginally above the estimates for a bundle of high income countries. Unemployment is at 4.9% and the Fed recently raised the federal fund rate from 0-25bps to 25-50bps. All these factors should lead to a stronger dollar in 2016, for the following reasons.

High GDP growth, especially relative to other high income countries, suggests a strengthening economy, one where there are more positive yielding investments. This will encourage foreign investment in the US, increasing the demand for USD. Unemployment at 4.9% is testament to this, and it is also a strong signal that the Fed will need to further tighten monetary policy. A further tightening of monetary policy will result in a rate rise, and with global monetary policy divergence, investors in low interest environments such as the Eurozone and Japan will seek to invest their money in higher yield American assets. Higher interest rates lower the price of bonds, increasing yield, and also result in higher interest rate bonds being issued. This should further increase the demand for USD and strengthen it.

So why has the USD fallen against the Yen by 6% since the beginning of February? The answer lies within Janet Yellen and the global economic growth story. There are fears, with falling oil and commodity prices, that the global economy is slowing down. Developing countries are making less profits from their exports, which is concerning as they make up 40% of global demand. Janet Yellen has made clear in her statements that she closely monitors global growth to determine the course for the Fed Fund rate. She has warned that American growth may slow down and that rate hikes may be held back in the near term. Both of these counter the statements made in the above paragraph, which argue the USD should strengthen.

Why is the Yen a safe haven when there are fears of global economic slowdown? The GDP growth forecast is half that of America (1.2% vs. 2.5%) and Governor Kuroda recently dropped the interest rate at the BoJ to -0.1%. This kind of environment should see the value of the Yen drop.

N.B In fairness the Yen has fallen from $/80Y to $/120Y since 2012, but this is partly a move by the BoJ to shake off currency strength. Strength that does not reflect its domestic situation.

Its safe haven status is partly because of its large trade surplus. Japan is one of the top 5 creditors globally, with Germany, China, Switzerland and Saudi Arabia. With such a large trade surplus investors are more willing to park there money in Japan, as the risk of Japan not paying its debts are relatively low. Another reason is market psychology, as a currency that traditionally rallies in risk averse periods it has become in some ways a self-fulfilling trend.

Yesterday David Cameron announced he had struck a deal with the EU, the GBP strengthened 1.025% against the USD. Today he announced a referendum on the BREXIT will take place on the 23rd of June. This is likely to lead to volatility in the GBP as the future of the UK becomes more uncertain. Markets loath uncertainty and the UK leaving the Eurozone is likely to raise questions on economic growth, immigration, security, global trade and the stability of the service sector. A UK staying in the Eurozone is unlikely to change much. Therefore it is easy to see why the GBP should rally at signs of the UK remaining in the Euro.

Currency traders should also be weary of strong economic growth in the UK, which is likely to put pressure on Mark Carney to raise interest rates. Although he has more recently mentioned that rate rises are unlikely in 2016.

2016 should therefore be an interesting year for the currency markets. The USD will depend on global growth and the words of Janet Yellen, the Yen may continue to strengthen against its weak domestic economy, and the GBP is guaranteed to be volatile in the build-up to the BREXIT.

Twitter: @ProdigyMarkets


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