Daniel Stanley, Head of FX at London-based foreign exchange specialists Global Reach Partners
Where has the time gone? 2018 seemed to have just started but we now find ourselves heading quickly towards the end of its first quarter. While there has been relative stability amongst the key currencies in the early part of this year, a number of key issues could impact the value of the Dollar, Pound and Euro in the months ahead.As ever, global businesses which trade in these and other international currencies will be keeping a close watch on emerging events and how the world leaders deal with them, hoping it will not have an adverse effect on trading and overall profitability.
Looking firstly to the US, the unpredictable antics of President Trump continue to keep the rest of the world engaged in the policy direction of the world superpower under his leadership. Putting aside Mr Trump’s sometimes brash and often unconventional approach to foreign policy matters – which in themselves have the potential to impact on the value of the US Dollar – domestic issues are more likely to determine the currency’s value in the months ahead. The first of these is the prospect of a further rise in US interest rates. After three rate rises over 2017, there is a strong expectation that we could see another three or possibly four increases from the Federal Open Market Committee this year. The continued rise in employment and the surging stock markets, which had some of the steam taken out of them in last month’s drop in many shares, are key reasons for these anticipated rises.
Another important factor is President Trump’s tax cutting agenda. This is seen as a huge gift to business and one that will fuel inflation.The overall bill for these cuts is expected to be around $1.5 trillion over the next decade, adding to the US’s existing $20 trillion debt.Anything that bumps up borrowing costs could hinder some of the existing growth of the economy as well as equity valuations.
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What could potentially prove to be the biggest threat to the value of the Dollar this year is the investigation over the Trump campaign’s ties to Russia. If evidence emerges that directly implicates Mr Trump in this saga, it could not only prove disastrous to his presidency, but could also drive down market confidence in the nation’s currency.
The precise impact all these issues will have on the value of the Dollar is impossible to predict at this stage. It is likely the leadership from the Federal Reserve will play a decisive role here. With Jerome Powell replacing Janet Yellen as the new head of the central bank, we are likely to see continuity in its monetary policy. Powell is seen as having slightly dovish tendencies, so with US export improvements being reliant on a weak dollar, he will likely take as cautious an approach as possible to policy tightening.
In the UK, the focus is primarily on Brexit. While it’s currently at its highest level since the 2016 when British voters chose to leave the EU, the Pound still has some way to go to return to its pre-referendum value. The sometimes fraught divorce negotiations between the UK and Europe along with the weakened British Government led by Theresa May are not helping restore a high level of confidence in Sterling. Last summer’s snap general election outcome, where the ruling Conservatives lost their overall majority, led to a two percent fall in the Pound against the US Dollar.The UK currency also continues to slump against the Euro. It fell to an eight year low in August before making a modest recovery to its current level of around €1.13.
Looking ahead, the rise in the consumer price index, triggered mainly by the fall in the Pound after the Brexit vote and rise in the cost of imported goods, is expected to peak later this year. With the Bank of England suggesting last month that interest rate rises are likely to come sooner than expected, this measure combined with a tailing off of inflation could bolster the value of the Pound.This, however, must be weighed up against longer-term uncertainty over how the UK economy will fare outside the EU and the effect this would have on Sterling.
Meanwhile, over on the European continent, things are looking a little brighter although significant challenges also lie ahead. On a more positive note, the European Central Bank is making progress in slowing down the pace of bond buying, outlining the current programme to now end in September this year. The credit crisis, which nearly brought the entire Euro project down, is now showing signs of abating. Some of the emergency loans taken by national banks are being repaid faster than was expected, pushing these institutions into being net buyers or accumulators of the Euro. It, therefore, follows that with growing demand for the asset, prices should also rise.
Potentially more worrying for the EU is the current political situation in Germany where Angela Merkel continues to struggle to form a coalition government. The prospect of entering a partnership with the SPD seemed a potentially stable option but, at the time of writing this piece, a critical vote on the coalition hangs in the balance with strong opposition coming from some leading social democrats, including the leader of its youth wing. The ultimate success of this coalition will likely determine Ms Merkel’s political career and will undoubtedly impact the wider single market economy.
For businesses which transact in these and other currencies, the need for diligence remains crucial in managing exposure and protecting profitability against fluctuations. Gaining an initial understanding of the level of risk is critical for globally active companies, so they are well-placed to set out an appropriate budget rate and create a suitable hedging plan. From there, a range of effective foreign exchange management tools, including forward contracts, spot deals and orders, can help them manage this uncertainty. It’s important they get the best advice on which ones are most suitable for their business needs.
With a high level of political volatility across the globe, 2018 has the potential to provide another roller coaster ride for the world’s economy. While the business community can have some influence on events that will, as ever, be limited. They must therefore ensure they are at least prepared for the journey ahead.