Why the FX market gives delayed reaction to some news

This attests to the inherently random nature of the FX market. For instance, President Trump’s ‘sacking’ of Fed Governor Lisa Cook bought no adverse reaction in the US dollar at all despite appearing to be very significant. However, we should not see this decision as unimportant; just that it may take time to weaken the US dollar.

The FX market is intensely frustrating. Its random behaviour is due to many factors. An important one is that not all FX transactions are carried out because the buyer or the seller is taking a view on the future value of a currency. This sets FX apart from other assets like stocks or bonds where purchases of assets are mostly made because buyers expect the price to rise, or sold by sellers who see a fall.

In the FX market, transactions such as trade flows, asset purchases, holiday currency transactions and many more are often undertaken without reference to a particular currency view. The currency trade just facilitates the transaction. This fact can often stand in the way of the FX market moving in a way that news announcements, like Cook’s sacking might suggest.

Another example here is the portfolio rebalancing that we see around month-end and quarter-end. For differing asset performance during the month, or the quarter between countries can generate rebalancing flows as investors seek to maintain fixed weights between countries. These rebalancing flows can create currency demand and supply that can easily dominate any macroeconomic or policy news that occurs around the end of the month or quarter.

Perhaps this is one reason why the FX market seems quite unresponsive to the news about Cook right now. But just because the FX market might not be responsive now, does not imply that it will be similarly indifferent in the future. Of course, it is hard to disentangle the impact various events, like Cook’s sacking might have on FX markets over time as numerous other market-moving events come along.

However, Steven Barrow, Head of Standard Bank G10 Strategy, states there are reasons why the market might be unresponsive now, but prove more receptive in the future. In terms of current FX market indifference, there’s not just the month-end rebalancing issue we’ve talked about, or other factors that might mean that the market was not appropriately positioned to react to such an event. There is also doubt that President Trump can sack the Fed governor. He doubts, for instance, that longer-term investors in US stocks or bonds are going to sell US assets quickly because of such an announcement when they don’t know if it’s legal. Instead, if there is a creeping threat to the Fed’s independence there’s likely to be a drip feed into other assets and away from the US, even if Cook keeps her job. This might not happen quickly.

After all, if the upshot of this is a Federal Reserve more disposed to cutting rates that’s good for stocks and the front end of the bond market, meaning that investors won’t beat a hasty retreat. But the damage could occur over the long haul should a compromised Fed allow inflation to rise unchecked. High inflation generated by the erosion of central bank independence will weigh on a currency down the road even if policy rates are belatedly raised to calm the panic – just ask Turkey.

Longer-term investors are likely to slowly reallocate portfolios away from the US to other markets and hence other currencies, leading to a steady decline in the dollar; not some sort of immediate capitulation due to a specific event, like Cook’s dismissal. Views such as these often lead to the quick rebuttal that investors can’t really go anywhere else such is the dominance of US assets like stocks and bonds. But we think that they can, and will.

“We have already seen evidence of it in central bank reserve management as banks have shifted towards ‘new’ currencies, like the Canadian dollar and renminbi and also towards some ‘old’ assets, like gold. These moves have not been rapid - and they won’t be when it comes to private sector investors either”, said Steven Barrow.