FX volatility could rise as central banks attempt exit from unconventional policies
The world’s leading central bankers want to normalise monetary policy raising questions over whether a great convergence story has begun between the rest of the world and the US or if it is merely a path to market chaos.
If central bankers are indeed targeting an exit from un-unorthodox monetary policies then expect plenty of uncertainty and volatility. They also appear to be calling time on the great bond and equity bull markets, which can also influence exchange rates.
For the last couple weeks, the Bank of England and the European Central Bank have been sending mixed messages to the market over monetary policy sending EUR and GBP all over the place with the latter managing to punch through 1.3000 on cable as short sellers covered. It now seems that the UK is heading towards higher interest rates earlier than thought despite some earlier confusion over its intentions. Though this is a surprising conclusion with Brexit in the wings and all that it implies for the economy.
The ECB, meanwhile, has been sending a message that monetary policy will remain lax despite the Eurozone’s strong recovery, but there is clearly pressure on the central bank to wind down its quantitative easing and move interest rates out of negative territory. The longer growth carries on and if inflation remains positive the harder it will be to maintain such lax policies.
On the other side of those trades there is USD, which supported EUR and GBP rallies as the USD index recorded its worse showing in seven years as traders have doubts over the US Federal Reserve’s ability to raise interest rates again this year, whether US President Donald Trump can deliver his economic growth agenda and indeed the economy might be slowing.
If central bankers really are trying to coordinate a move towards exiting extreme monetary policies then volatility will increase. Good GDP and higher inflation numbers will hit equities and fixed income markets harder and could conversely benefit EUR and GBP if traders think there’s a realistic prospect of tightening monetary policy for those two currencies.
It is notable though that the Bank of Japan is sticking firmly to its guns on monetary policy suggesting upside for JPY could be limited unless utter pandemonium breaks out in the markets at which point Japanese investors repatriate in mass to their home country sending their currency soaring.
Central bankers are taking this stance because global economic growth has been firmer recently. However, this may not be as positive as it looks. There’s speculation that the US could be heading for a recession in the next 12-18 months and the rest of the world would follow. Also, European growth tends to be quite strong towards the end of an economic cycle. Yet another factor is can the world take higher interest rates?
It has taken extreme monetary activity to get relatively modest growth rates suggesting scope for higher interest rates – and never mind completely unwinding quantitative easing – are limited at best. Governments, corporations and consumers in many leading economies are deeply indebted.
If recession is on the horizon, the type of convergence that does take place could be very different -- one where the Fed is easing monetary policy once again and joins the other major central banks with very lax monetary policies in a race to the bottom.
TECHNICAL ANALYSIS: EUR/JPY look close to consolidating
EUR/JPY has just enjoyed a sharp break-out rally and looks set to build another consolidation pattern, which could last anywhere from a few weeks to a few months with the possibility of another leg up once that pattern completes.
In fact, the pair are at levels not seen since early 2016, but still far from highs of just under 150.00 recorded in December 2014 following a two and half year monster rally from lows of around 95.00. A repeat of that performance will require sustained divergence in economic and monetary trends between the Eurozone and Japan.
But in the meantime, a consolidation looks in order starting sometime this week. The pair are riding outside the upper Bollinger band and are in overbought territory on the daily RSI at levels of 77. They are also very far above their 200-day moving average suggesting the upside could be limited in the short to medium term.
Resistance levels can be seen at 128.65, 128.83, 130.05 and 131.68 with support at 127.97, 127.59,127.38 and 126.97
By Justin Pugsley, Markets Analyst, MahiFX