How to trade the FX market

The low volatility and range-trading we saw before last week’s FOMC meeting has been broken by the Fed’s new forecast of two rate hikes in 2023.

The low volatility and range-trading we saw before last week’s FOMC meeting has been broken by the Fed’s new forecast of two rate hikes in 2023. But there are many factors to bear in mind here that lead us to feel that any USD support these new forecasts will be ed. Standard Bank’s forecast for EUR/USD before the Fed meeting was that there would be a short-term slide into a 1.15-1.20 range, but with a longer-term target of 1.30 over the coming year. These forecasts have not changed since the FOMC meeting.

 “The first thing to note about Fed policy is that this bank is not ahead of many other central banks when it comes to lifting rates – unlike the last rate-hike cycle which the Fed kicked off in December 2015. A second fact is that the last time we saw the Fed move to signal a tighter monetary course, during the infamous 2013 taper-tantrum, we did not see USD rally substantially and that was despite much higher treasury yields. Fast-forward to today and longer-term treasury yields have fallen since the FOMC meeting. Inflation expectations have fallen as well, so real yields have risen slightly compared to the euro zone, for instance, but our concern is that inflation risks are still elevated and hence real US rates won’t offer the dollar significant support going forward. With this in mind, we might also find that other so-called ‘safe’ currencies such as JPY, CHF and even EUR perform well against USD, even if USD rises against ‘riskier’ currencies as inflation fears undermine risk assets such as equities and corporate credit. EUR should benefit against EUR as the economic recovery strengthens. And while this might not lead to the sort of monetary tightening that seems likely the Fed in coming years, it is still likely to be the case that the pace of ECB bond purchases will slow down next April after the Pandemic Emergency Purchase Program (PEPP) comes to an end next March”, Mr. Steve Barrow, Head of G10 Strategy at Standard Bank emphasized.

Another point is that the trade performance of the euro zone has stayed quite resilient. Of course, that might partly be because demand has been slower to take off than places such as the US and UK, but even as this happens the Standard Bank thinks that the trade surplus will stay robust, in contrast to the US, where more deterioration seems very likely. For now, US trade and current account weakness is being counterbalanced by robust capital inflows, especially into treasuries, but it is sceptical that this will continue.

For a start, many central banks outside of the US are essentially covering the new debt issuance their governments and that’s crowded out the domestic private sector, possibly pushing them towards treasuries, where the supply of new debt is much stronger. But as central banks slowly start to taper bond purchases, so the supply of domestic debt available to the private sector will rise and could pull funds back treasuries. This move could be exacerbated if longer-term treasury yields continue to come down as we have seen recently.

Mr. Steve Barrow said: “We are sceptical that US yields will fall substantially but, by the same token, also feel that rate spreads will not diverge significantly in the shape of much higher US yields relative to elsewhere given that inflationary pressures are rising globally and the Fed won’t be one of the first G10 central banks to hike rates. All told, while USD is seen rising further in the short term, we still view the longer-term directional trend as one of weakness. GBP is seen rising to the 1.50-1.60 range against USD over the next year, or two, as the greenback slides. But here too there are short-term risks of a slide, perhaps as low as 1.30 should UK- EU tensions over Northern Ireland reach breaking point before the end of the month. But while it is conceivable that the UK provokes the EU into retaliatory actions by unilaterally extending the concessions that are in place for trade between the mainland and Northern Ireland, we suspect the two sides will row back and the dispute will end amicably”.