Dollar and sterling concerns
Is the dollar flickering back into life and when will the pound reach its bottom against the euro? Richard Blackden puts these questions to Simon Derrick of BNY Mellon.
Presented by Richard Blackden and produced by Fiona Symon
Is the dollar flickering back into life? When will the pound reach bottom against the euro? Welcome to Hard Currency, the FT's weekly look at some of the biggest trends in the currency markets. I'm Richard Blackden the FT's deputy markets editor. And joining me is Simon Derrick, Chief Currency Analyst at BNY Mellon.
Simon, August is typically quiet in the currency markets. It's not something we've seen actually so far this month. The US currency, big story this year. It's weak, at least measured by the dollar index hit its high for the year in early January. Can you just give our listeners a broad sense of what's been ailing the dollar so far this year?
Well, I think it's declining expectations about US growth, and declining expectations about policies that will drive those growth. You remember end of last year in the immediate aftermath of the election, there was a lot of talk about infrastructure spending programmes, and a great belief that what you would see is a supercharged growth cycle taking place in the US. That drove the dollar to remarkable highs, the high of the trend for the last four or five years. And then as we got through this year, and we've dealt with the difficulties of getting legislation through, and in fairness, mild numbers coming to the US.
That expectation is moderated. Yields are moderated, particularly against some other countries, or other areas like the eurozone. And after five years of dollar inflows, people have simply said well, maybe there's some better places to go and see yield.
And in terms of the rest of the year, do you see anything reversing that trend? We've got a big couple of months coming up in terms of the US political scene. As you said, there's been dwindling expectations that Donald Trump and the Republican controlled Congress will get a big economic stimulus package through.
Towards the end of September, we have the debt ceiling needs to be raised in the US. This is a sort of self-imposed borrowing limits for the US government. It's been a difficult wrangling point in the past, particularly in 2011. Do you see that's been a big issue potentially for currency markets?
It can be. Indirectly, and in the long term in 2011, yes it did. And the reason for that was actually-- it actually had an influence on [INAUDIBLE] China thoughts about its holdings of US treasuries and about what it wanted to do with its reserves. I was very aware that this week we saw the comments coming out from Fitch about what might happen, whether it be further concerns about raising the debt ceiling. They talked about maybe taken away the AAA rating for sovereign debt.
Yeah, the margins, that can absolutely influence the dollar. It can absolutely influence what investors and particularly reserve managers do. Whether we'll get there or not is an entirely different issue. We always seem to have this debate.
I suspect that ultimately we'll get through it, and the debt ceiling will be raised again. But we've already got the posturing taking place this week. So again, never say never on these things. The other side is we've obviously got this issue about whether the Fed is actually going to start reducing its balance sheet. All the indications are that it will. And it seems to be a reasonable likelihood that we will see a hike by the end of the year.
But, if we have a stumble around the debt ceiling, that could lead to the Fed postponing a possible rate hike. Equally, if we started to see the numbers slow down-- and there are some early warning signs about the global economy that maybe things are slightly weaker than maybe we expected-- maybe we start to think that in 2018 the Fed becomes far more cautious. If that's the case, then again I'd say that the dollar starts to look really quite beleaguered over the course of the next 18 months or so.
Perhaps one of the biggest surprises to some people this year has been the performance of the euro. As it began the year, some people in the market talking about parity against the dollar. This is the potential prospect of Marine Le Pen getting elected as French president, and that didn't happen.
And really since then, and particular since Macro won that election, and those good improvement in the eurozone economic data, the euro, particularly against the dollar, has performed incredibly well. Are euro bulls getting a little carried away at the moment? Or do you think that there is actually real legs to further move higher in the single currency?
I think history says that there's plenty of place for the euro to go a lot higher. If we go back and we tackle the political issue first, clearly if we go through the end of last year, beginning of this year, there were those political concerns. Understandably enough, given the stumbles that were in 2016 and the miseries that were in 2016. But once we have the Dutch election, out of the way-- more importantly, once we have the French presidential election out of the way, and the Italian election was pushed back seemingly to 2018, those concerns dissipated-- and what you saw a lot happening was a lot of money that had saw safe haven status in core Europe starts to flow out and seek those high ideals in the periphery.
The impacts of that was it actually drove up German yields. relatively speaking. That's after using the benchmark and the effects for the eurozone overall. You saw people starting to actually seek those yields. That was the first thing that really started to drive the euro higher.
The second story is obviously been about the idea that the ECB would like at some point to start tapering its asset purchases. It's already reduced them once, but we're talking about further reductions. If you look over the course of the last four years, and you strip out this one elements of politics that we saw this year, prime driver for the euro has been expectations about shifts in the asset purchase programme. And so the very fact that we're talking about that clearly is going to supercharge the euro from here on in. And I think as long as there are expectation's there, euro's going to be heading high.
The question is the Europeans have made it quite clear, they're not very keen on a high euro. It was suddenly embedded in the ECB comments. But if we go back, history says that they struggle. They do struggle to find a strong euro.
Remember Mr. [INAUDIBLE] 2004, 2005, 2006 talking about those brutal moves. It's hard for them to come up with anything really credible to fight against the euro strength. And particularly if you start to see some of those reserve managers in the reserves growing, and looking to diversify their more aggressive pace--
So this goes back to your point about potentially the ramifications for a very messy debt ceiling.
Absolutely. Where that to become an additional long term fight. So weighing in on how people look at the US, and how reserve managers look at the US, and particularly given that the eurozone crisis is now fading in their memory somewhat. Here, the euro still represent the most credible alternative reserve currency out there.
So you can see a variety of factors that could really drive the euro a lot higher from here. Obviously, we've got to get through the next few months. But could we be well beyond 120 some points in the early parts of next year? Yes, absolutely.
Now one of the currencies the euro's been pairing higher against is sterling, of course. Very relevant, as we're here in London. One curiosity that we've had so far this month basically, is that you might argue the political developments for the currency have broadly been positive. So you've got the chancellor here in the UK, Philip Hammond make it very clear that a soft Brexit, or one that puts the economy ahead of any other considerations in terms of the implications of exiting the EU is a priority. And you've had some other cabinet colleagues echo that.
Sort of 12 months ago there might have been fiscal developments that would have really buoyed the pound. They haven't. And in fact, particularly against the euro. It's not so much against the dollar, but against the euro sort of trading at an eight year low. Why is that?
Well, I think that you're right to highlight that the move against the dollar has been particularly dramatic, although it is getting a little bit of momentum. It's primarily been a euro move rather than a sterling move. But I do think that the way sterling is performing overall is actually quite fascinating. Because this is normally a period when actually sterling is relatively calm. It's that summer lull when Parliament is in recess, and there's not a lot of political forces.
You go back 12 months ago, Bank of England cut rates by 25 basis points in August of last year. Sterling barely stumbled. It did nothing until the party conference season and Parliament came back from its recess. This time around, we had the election. But almost instantly we had the Bank of England meeting where there was a narrower than expected vote on the idea of raising rates.
And I suspect that idea that maybe there was going to be a rate hike helped provide some temporary relief for sterling through June and July. But of course, start of August we had a Bank of England meeting that went right back to normal. And that idea that we're going to see a rate hike simply disappeared. And without that, we've seen the sterling that has sunken somewhat.
[INAUDIBLE] I think we're 2 and 1/2% plus down on the sterling index since August 3. That's unnerving. For that to be happening in a relatively quiet period for sterling, what should be a quiet period for sterling, and coming up to what it looks as an incredibly busy period over the next two months with political events both here and in Europe, I think that's concerning. We've got the negotiations with Mr. Barnier, we have this Conservative Party Conference, we have the reading of the Great Repeal Bill. Those are things that investors are going to be looking at carefully.
Hopefully we can get through them all. But they present potential stumbling blocks for sterling. And at a time when it's already weak, maybe we are going to start seeing pressure towards some of those really big levels suddenly against the euro that we've talked about it over time.
So in terms of westerly might draw some comfort, let's assume the politics-- if it's not responding to the politics right now, and the politics don't get particularly better for sterling over the rest of the year, we've had signs of weakness in the economy. Does the economy need to tell people that actually it's doing fine? And some of maybe the top [INAUDIBLE] in the eurozone economies to come off. Is it relative economic performance that will be key if sterling's going to find some support?
If it's not the politics, then yes, it's got to be that. I mean, clearly, the thing that is holding everybody back is that uncertainty. And so if we get a little bit of that uncertainty removed, then it will come back to being about the relatively speaking, the economic path. The problem is, of course, that here in the UK, there are those early warning signs that maybe the economy is slowing a little bit. I'm still a believer that one of your best and early indicators is the housing market, which certainly with London has been slowing down steadily. And a few signs that those ripples are starting to spread.
And there's a few other little indicators. Some of the results [INAUDIBLE] quite from companies over the course of this week have perhaps been a warning that things may be slowing down a little bit. There, I think investors are going to be looking for that sign that maybe we are going to see a little bit of a dip over the course of the next 12 months or so. In which case, any chance of a Bank of England rate hike really starts to dissipate. And in which case, sterling really does start to suffer.
So given we've got to roughly 92% pence against the euro this week, let's get into September and October. Is the possibility that some people in the currency market are calling for of parity against the euro a realistic one? Or is that a kind of outlandish--
Oh, never say never. I mean, you know let's absolutely straight here. Sterling has essentially gone down against European currencies for certainly at least since the Nixon shock in '71. And I'm pretty certain that if you track back further, you will see the same thing. If you look at sterling more generally, the path since the 1930s has pretty well and much be one way.
Whilst authorities have fought against evaluations of its own, ultimately they've always buckled. You know, 1967 or 1992. So to say the resumption of sterling weakness would be radical, I think flies in the face of history. So clearly it is possible that we could start to have a look towards parity should these forces continue to conspire against the politics and economics. The interesting question would be would the authorities feel comfortable with that?
Would they really want to see sterling testing toward parity? Or would they feel that that was perhaps something that both from an important inflation perspective, and as well from a perspective of maybe just causing more concerns going into the negotiations with the EU maybe they wanted to do something about it, whether that was hiking rates or not. I don't know. But I think that getting towards parity would certainly start to make people sit up and take notice.
Yeah, that certainly feels absolutely right. Simon, thank you very much for sharing your thoughts on what's been nothing but a quiet August for the currency markets. And thank you for listening to Hard Currency. We'll be back next week.