FX market special: the new order for G10 FX

There is a shift occurring in the FX market that could suggest a change in some of the key FX trends of the year so far. Firstly, the dollar looks like it may have found a temporary bottom, the euro is powering ahead and EUR/GBP at parity is fast-becoming a consensus call.

There is a shift occurring in the FX market that could suggest a change in some of the key FX trends of the year so far. Firstly, the dollar looks like it may have found a temporary bottom, the euro is powering ahead and EUR/GBP at parity is fast-becoming a consensus call. The yen and Swiss franc have given back some of last week’s gains but remain sensitive to geopolitical fears, and the pound is starting to wither once again and could be in for another tough few months.

Scandi’s come out on top

Looking at the performance of the major FX pairs over the last 6-weeks, the standout performers have been the Swedish krona and the Norwegian krone, followed by the euro. The SEK has rallied ever since the Swedish central bank dropped its easing bias back in June, and there could be further upside to come now that rising inflation could push the Swedish monetary authorities to raise interest rates.

Central banks rule the FX roost

This highlights a key theme in FX markets right now: central bankers, both their words and their actions. As we lead up to next weekend’s Jackson Hole central bankers’ conference in the US, the focus will be on the Fed’s Janet Yellen and the ECB’s Mario Draghi. The risk is that Draghi announces an end to the ECB’s Asset Purchase Programme and Janet Yellen all but confirms a further rate rise later this year. While we expect Draghi to disappoint at Jackson Hole, the ECB might make an announcement regarding the fate of the APP at its next meeting on 7th September.

This leaves the pound. The BOE tried to convince the market that a rate rise will happen, however, the market is unconvinced and this is weighing on the pound. Weakening inflation pressure and a disappointing economic outlook keeps investors’ cool on the pound. If Carney delays the BOE joining the global rate-hiking/ balance sheet-tightening cycle then we could see the pound overtake the dollar as the funding currency of choice for the rest of this year.

Global capital flows and FX trends

But the Bank of England is not the only thing that could weigh on the pound right now. Capital flows are also leaving their mark, and right now the UK is not an attractive destination for the world’s capital. A survey from Bank of America Merrill Lynch said that “Anglo Saxon political angst” is spurring a shift in investment away from UK and US equities in to Europe. Thus, political problems, namely the Brexit negotiations and the hobbled Tory party, remain a threat to the pound as it makes the UK a less attractive investment destination, with investors choosing Europe over the UK.

The capital flows theme is the key driver of EUR/GBP in our view. Earlier on Tuesday, EUR/GBP reached its highest level since October 2016 before it gave back some recent gains. As this pair moves towards 1.00 we expect some setbacks, but we also expect most of these to be technical – options expiries, positioning etc. The structural trend remains in place, and as Europe’s economic and political climate warms then capital flows should continue to boost the euro at the expense of the pound especially, and even the dollar. Parity in EUR/GBP by year-end does not seem beyond the realm of possibility.

The future of the dollar

We mention above that there are some tentative signs that the dollar is about to stage a recovery. This includes the performance of the USD/ILS (Israeli shekel), which is a lead indicator for the dollar index. USD/ILS actually started to recover in July, and has consolidated its uptrend in recent weeks. Also, the dollar index has jumped out of oversold territory according to the 30-day RSI, which is a sign that sentiment towards the dollar is changing.

However, although this points to a recovery for the dollar, political angst is also a concern for the US. Thus, until we see a serious hobbling of the Trump administration, which may not come until the 2018 Congressional mid-terms, the buck’s recovery may not be broad-based for some time.  We expect it to perform well against the pound and the Scandi’s, and in times of market calm it should also do well vs. the JPY and the CHF, however, we think that it may struggle to gain traction against the euro due to global capital flows, which continue to favour Europe over the US.

The future of FX

We expect the euro to leapfrog the Scandi currencies in the coming weeks, and be the strongest currency in the G10 as we move towards year-end. We expect the pound to dwindle towards the bottom of the pile, as structural factors remain limiting the pound’s attractiveness. We expect there to be further flare ups in volatility in the coming months, which could keep investors’ nerves on edge and demand for JPY and CHF relatively strong. As we mention above, the dollar is due a recovery but it may not be broad-based for some time.  

Join our live webinars for the latest analysis and trading ideas. Register now

GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.