Policymakers push politicians aside
Politics was the driver of the forex market at the start of the year, but its influence is now waning, says HSBC's David Bloom. Investors are far more focused on monetary policy and interest rate differentials, he tells Roger Blitz, although pockets of political risk persist
Presented by Roger Blitz and produced by Fiona Symon
Welcome to Hard Currency, the weekly Financial Times podcast on the foreign exchange market. I'm Roger Blitz, and the euro's impressive run of late this week went into sharp reverse. At one point, it was down 2% against the dollar. So, what's bugging the euro? Is it Angela Merkel's hollow victory in the German elections, the market finally getting behind the dollar, or quite simply that the euro rally has come to some kind of natural end?
Well, with me to discuss all these issues is HSBC currency strategist David Bloom. David, welcome.
What did you make of the euro reaction to the Merkel hollow victory?
Well, I think, to be honest, it's come to a natural end. We reiterated our 120 forecast for the next 18 months or so. And at the time, the euro was on the tear, and people were saying you've been the most bullish in the market. Why not more. Why not 125? Why not 130? And I think it's come to its natural end in the sense that we were pricing in tapering by the ECB. We were pricing out political risk because the big political risk was actually France not Germany, and that's behind us now. So I think the euro has come to its natural end. The FX market has been preemptive and looking forward to the ECB doing some tapering.
Political risk was a big thing at the beginning of the year-- as you mentioned, the French election. But when we come to look at the start of 2018, are we going to just be a little bit more phlegmatic about any political risk upcoming?
Yeah. I think that political risk is already tapering off to use that expression. This is now about economics. Long live economics. This is about central banks. Who's going to tighten? And What's the Fed going to do? That's really what it's about. I think the great political moves, starting with Abe in 2012 and Brazil and South Africa, Turkey, Brexit, Trump, French elections. That's behind us now. We're now looking, which central banks are going to tighten, and we want to buy those currencies.
What you're saying is we're entering a new phase. Just walk us through some of the previous phase. You've written this week about we had a structural phase. We then had a political phase, which is now ending. And we're now coming to a cyclical phase.
I don't like-- I mean, we've got these five-year time frames. But if you recall the financial crisis, 2007 roughly to 2012, was all about fiscal policy, fiscal expansion. It was about debt to GDP, the sovereign debt crisis. That's the structural one. And then ends on the day Draghi says we'll do what it takes.
And then we get the Japanese election, 2012. And there, dollar-yen goes from 80 to 125. That's like a 40% depreciation in the yen. And you get the Brazil impeachment of the president. You get changes going on in the UK with Brexit and Trump. And now, we think that has really ended again with the idea that Macron wins the election in France. The risk of the euro breaking up and some anti-European politician taking helm has not happened. Now, we're moving on to which central bank is going to raise rates. We're in the economic cyclical phase now.
I mean, ironically, we were talking about 18 months ago, 12 months ago, about how the central bankers were going to be passing the baton on to the politicians. Do you remember that phrase? They were done and dusted. Now, what we're talking about is actually very much the baton is still in the grip of those central bankers.
Yes, I think it is. And I think also, we've written a piece called "FX, the new central bank," because it's actually the foreign exchange market that is a kinder, gentler market. We aren't the psychopaths of old. We are much nicer. We go with the market. We go with the central bank. We give them what they want.
So what we did with the euro, we chased it to 120, and we said to the ECB, let's see if the economy can sustain it. And then they said, yes, it can. And now they say, OK, we can do tapering. So we give them the tightening. They see whether that tightening the economy can absorb. And if it can, then they move to balance sheet reduction or interest rates.
OK. All right. So it's not necessarily the end of political risk. I mean, clearly Brexit is going to be a big driver of sterling. And to some extent, we can still expect Trump to push the dollar up and down.
Yeah. You're absolutely right. I mean, on any day, any of these factors can matter. But I think in the broad scheme, people are asking themselves, how come we're getting these political events and we're not getting much movement in the currency? I'm saying they're mattering less. We're talking about what's dominant rather than it's gone.
But yes, I mean, we made the big mistake with the UK, I have to admit. We were forecasting sterling to fall this year, and the market said, we don't care about politics. What we care about is the Bank of England's going to raise rates. But I think it's going to come back. I think political risk in the UK and the structural current account deficit is not over, and that will come back. And that's why we're still bearish on sterling for a 126 print by the end of next year.
OK. So that's the exception on your theory about the cyclical period that we're now in. But I suppose, Shinzo Abe calls an election in Japan, and an investor would be naive to expect that the yen is going to move that much.
Yes. But in 2012, it's like the biggest thing since sliced bread. You know, it's enormous, and dollar-yen goes from 80 to 125. And this time, if I showed you a chart and said, where did he call this snap election, you'll go, I can't see it on the chart. Tell me, David. So what I'm saying is you can see it doesn't matter as much.
I just want to give you one example of structural versus cyclical.
The emerging markets, the Fragile Five. So we sell South Africa and Turkey and India and Indonesia and Brazil during 2014. They've got huge current account deficits. Structurally, we're worried about them. The current account deficits are too big relative to interest rates. We sell it. Today, we're in a cyclical world. We want to buy them because the interest rates on offer are much greater than the risk of the current account deficit. Nothing there has changed. We as investors change our profile of risk into new regimes. And something that was unacceptable before is now totally acceptable and is to be bought not sold, but nothing in these countries have actually changed. We've changed.
But emerging markets, they're going to come under pressure from a possible stronger dollar with what we've seen this week?
Not particularly, because I don't think it's a trend to dollar move. We've had a few percent here or there. We're talking about perhaps tax changes in the United States, which would be a big thing. We're talking about the Fed raising rates. You know, they would make terrible assassins in central banks because they tell you when they're going to go arrive and what time and when. So they spoon-feed us. As I said to you, in sequencing, FX moves now, the central bank will move in December. So by the time the Fed raises rates in December, it's done. We're pricing in a rate rise for December now. That's why the dollar's rallying.
And since we're talking about emerging markets, Brazil and South Africa, which have been pretty volatile currencies with regard to political risk, what's their prospects now? Is the market quite phlegmatic about all that?
Yeah. I think when we talked about Brazil in 2014 and the impeachment of their president and then the next president they threatened to impeach, the one you get a massive reaction. And the second one, you hardly get a reaction. In South Africa, van Rooyen was made finance minister. The rand went absolutely ballistic. After three or four days, Zuma is forced into an about turn, and we get Pravin coming in as finance minister. This year, Pravin goes, and the rand hardly moves.
So what I'm saying is what? The exact same kind of events previously caused massive moves, these political risks cause much smaller moves. This might be a mistake by the market, but that's how it works.
So at the moment, emerging markets seem somehow to be bulletproof from politics, and the rates on offer they have are more than sufficient for the risk. That's the mindset-- right now, right now-- in this cyclical world.
OK. In this cyclical world, therefore, do we look at the major currencies as the ones to watch to move, that are going to move, or do we look elsewhere?
Yeah. I think we've got Australia in the first quarter. They're facing the idea of this Phillips curve, low unemployment rates, earnings are not picking up, the central bank saying no we're not going to raise rates. But we know this is the disease that's happening. Started with the Fed, moved to the UK, it's going to move to Australia. The unemployment rates are too low, and wages are just about to pick up. This is the mindset. And if the Australians start moving towards thinking about a rate rise, the Australian dollar will rally. That's why we buy it now.
Then we've got Norway and Sweden in the second quarter of next year, and then in the third quarter New Zealand. So in the G10, there's still lots of juice for these central banks to raise rates. And we saw it in Canada. As soon as they warned us about a rate rise, the Canadian dollar rallied over 10%. That's still coming to Aussie, Kiwi, Noki, Stocki. So in the G10, plenty of juice, but it's in the little one's, not the big euro-dollar, I'm afraid.
My thanks to David Bloom of HSBC. Next week, it's the Conservative Party conference. That was a big driver of sterling last year. Will it have the same effect this time? Join us again for Hard Currency. For me, Roger Blitz, it's goodbye.