Interest rate differentials likely to return as forex drivers
As the major central banks exit unconventional monetary policies — more conventional measures such as expectations around interest rate differentials are likely to re-establish themselves as key drivers in the currency markets.
Expectations around interest rate movements rather than quantitative easing are increasingly likely to become drivers of currency movements. Indeed, with the US well ahead of the pack on that front, the USD index has been staging a modest uptick since September and is above the 50 day moving average and closing in the on the 200-day one.
The US Federal Reserve started edging rates higher from December 2015 and will likely do so again next month while reversing its quantitative easing policy. The Bank of England raised rates 0.25% last week for the first time in a decade and the European Central Bank is tapering its QE program and may raise interest rates in 2019. Of the majors, only the Bank of Japan is keeping the pedal to the metal on QE.
This would represent a form of ‘normalisation’ and would likely increase the popularity of carry trades.
Nonetheless, for this return to the ‘old normal’ to become established, much will depend on the ability of economies to stomach more expensive money. According to the Bank for International Settlements, the world economy has accumulated another $57tn in extra debt and there is a suspicion that very cheap money has kept many ‘zombie’ companies alive, which is helping depress productivity growth and even the dynamism of developed economies. In a world prone to populist politics few politicians will be keen to tackle these problems head on for fear of the social consequences.
However, for as long as the Fed is in rate-rise mode, the USD should move higher. Indeed, the US economy is doing well and President Donald Trump is starting to make some progress with his promised economic reforms. However, Janet Yellen’s term as chairwoman ends on Feb 3, 2018 with Jerome Powell nominated to take over. He’s is a Fed insider and likely to take a similar approach to Yellen, albeit possibly a slightly more dovish one. Uncertainty around that could unsettle USD a little during Q1, 2018.
TECHNICAL ANALYSIS: EUR/USD consolidation likely to break
EUR/USD consolidated last week, which could well be breached this week with support around 1.1600 looking vulnerable. This pause has enabled some indicators such as the RSI to return to more levels and also to stop pressing down quite so hard on the lower Bollinger band.
However, there are soon likely to be attempts — possibly driven by news catalysts — to move the pair out of the otherwise very narrow range of roughly 1.1600-1.1700. Having broken below the neckline of a fairly large head & shoulders pattern (usually a bearish sign), the probability is that any breakthrough will be on the downside.
Resistance can be seen at 1.1660, 1.1672, 1.1776 and 1.1802 with support around 1.1556, 1,1514 and 1.1468-70.
By Justin Pugsley, Markets Analyst, MahiFX