Bad news for USD bulls: There may be no US interest rate rise this year
The world is having to get used to a new reality. China is no longer a hyper-growth economy and may in fact be harbouring some quite serious problems, which equity markets have responded to with vicious sell-offs.
But this has big implications for USD and other currencies. If this environment of big stock market and commodity sell-offs continues amid growing fears over global economic growth it is very likely that the US Federal Reserve will not raise interest rates for fear of making the situation worse.
Only a couple of weeks ago markets were widely expecting US interest rates to rise in September with the Fed encouraging that view.
If the Fed is to leave its policy unchanged that clearly removes much of the impetus behind USD’s rally this year. Indeed, it is already losing ground from highs of around 100 on the US dollar Index (USD versus a basket of currencies) to lows of around 92 recently. It could fall quite a bit further except against the commodity currencies, which are more exposed to China.
The US economy is in a fairly benign environment with steady economic growth, falling unemployment with moderate wage rises and low inflation. In terms of economic fundamentals there’s no pressing urgency to raise interest rates very soon.
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The situation in China is worrying
China on the other hand is grappling with a huge stock market sell-off despite official attempts to stop it. There’s growing evidence that its economy is slowing, possibly quite quickly. Following decades of hyper-growth it’s likely that a pronounced slowdown will reveal all kinds of serious financial shenanigans in the system, which the authorities will have to deal with. As the West knows only too well the bursting of financial bubbles can weigh on economic growth for years.
China might therefore be about to become a serious drag on the world economy and this is particularly bad news for commodity currencies, such as AUD, NZD, ZAR and others. It’s very likely China will respond with increasingly large liquidity driven measures maybe eventually even some form of quantitative easing.
The recent devaluation of CNY is very likely continue as China will seek to chase more export orders basically joining in with what other countries have been doing this since the financial crisis.
For the rest of the year markets are likely to remain volatile. There could be some good news from the US and the Eurozone. A weaker USD might help the former and the latter has been showing some signs of growth particularly in the troubled periphery economies (Spain & Eire).
But for the time being the focus is firmly on China. It accounts for 15% of the global economy and worryingly has very opaque markets, economy and politics. This will exacerbate fears and speculation as to what is really happening there.
By Justin Pugsley, Markets Analyst MahiFX