All eyes are on the Fed as its July rate meeting comes to an end. Whilst no-one expects a rate rise tomorrow, and the Fed Funds Futures – a market based indicator providing a numerical probability of the chances of a policy decision – is pricing in 0.0% chance of a rise, many will be scrutinizing the policy statement for early warning signs in the language.
Continued improvements in the labour and housing markets will probably be mentioned as both these areas have seen very positive data.
The renewed sell-off in commodities, however, may make the FOMC think twice before considering an early interest rate rise. There is even speculation they may re-word their statement on inflation after market based indicators have fallen even lower than they were in June.
In addition the Fed may delay because it fears the implications of hasty rate rise on emerging economies, which would probably suffer and are already hurting from the slump in commodities.
The euro side of the pair is more stable in terms of its monetary policy outlook; the ECB has said it will see its QE programme through to conclusion no-matter-what.
A recent report from the IMF warned that the region is vulnerable to shocks and the ECB should increase its QE, however, it is unlikely to influence Frankfurt immediately, who will take a much more cautious approach.
In my opinion the euro-zone economy has a lot of growth potential which could support the euro in the mid-term, including a low exchange rate, cheap, plentiful and well skilled labour, and more business friendly reforms compared to the past.
Again the risk is that the FOMC will shift to a more doveish position and this will hurt the dollar and support the existing but very young EUR/USD rally.
Expectations of when the BOE may raise interest rates are now almost equal to the Fed, the most hawkish of central banks, with the consensus for a February 2016 hike versus January for the Fed.
One factor favouring the pound is that wages are rising faster in the U.K than in the U.S, and as long as this continues it will probably push cable higher.
Recent U.K GDP figures for the second quarter showed a surprise increase in economic growth, which further encouraged speculation of an early rate hike.
The expectations may be overdone, however, as the underlying data showed almost all the growth came from Services and consumer spending – not Manufacturing, which actually contracted. This was due to the strong pound reducing the competitiveness of U.K exports.
Both economies have the same problem: a combination of stubbornly low inflation and the strong exchange rates, and these could lead both the Fed and BOE to retrench and possibly delay raising rates, since a rate hike would actually exacerbate the problem – as far as the impact on cable is concerned its more a question of degree.
It increasingly looks as if predictions that the BOJ will have to increase monetary policy easing to have any chance of meeting its 2.0% target by autumn 2016 are coming true.
Growth remains tepid with the BOJ having to revise down its expectations on two occasions in the last six months of BOJ meetings.
In a recent report the IMF highlighted the problem of Japan’s ageing demographic and how this would continue eroding economic growth and performance. Combined with an increasing debt burden, which is set to hit 300% in 2030 the country is potentially set on a dangerous course.
According to the analyst Adam Button of ForexLive.com these factors make the yen a “slam-dunk” shorting opportunity over a very long 20-year time-frame.
Counter this against the Fed’s relatively hawkish stance and there seems to be more room for the yen to weaken, however, the picture is complicated by the yen’s role as global safe-haven. So much depends on whether there are any global financial crises, and this additional factor could have a greater or lesser influence regardless of the differential between central bank monetary policies.