Recent FX market volatility may have focused on the yen and particularly the pound, but a number of other currencies will find themselves in the firing line during the coming months.
Deutsche Bank recently suggested that the UK’s predicament has to be viewed in the context of a large global withdrawal of capital. An improvement in global risk appetite would almost certainly help the pound, but the bank is concerned that with one of the largest bond markets in the world having experienced a foreign buyers’ strike, markets may ask which country is next.
Inflation remains an issue, as well as domestic growth. Both of these are global themes that are seeing the USD rise in strength
Charlotte Hampshire-Waugh, StoneX Financial
The pound has undoubtedly been in a particularly precarious position, but the majority of currencies can be seen to be in the same boat, according to Charlotte Hampshire-Waugh, global head of trading payments & FX at StoneX Financial.
“Inflation remains an issue, as well as domestic growth,” she says. “Both of these are global themes that are seeing the USD rise in strength.”
European currencies are expected to face continued headwinds, says Paul Mackel, global head of FX research at HSBC. “The ongoing energy crunch and geopolitical uncertainties put the European currency bloc in a difficult position,” he adds.
Currencies that are exposed to risk and cyclical growth, as well as housing market vulnerabilities, are likely to face high or higher volatility, and these include SEK, AUD and NOK, according to Vasileios Gkionakis, EMEA head of FX strategy at Citi. He warns that growth is likely to decelerate further in the absence of any meaningful Chinese stimulus, while higher rates will weigh significantly on housing.
Kenneth Broux, head of corporate research, FX and rates at Societe Generale, agrees that the euro and the Australian dollar will come under pressure before the end of the year.
“EUR is vulnerable because of the escalation of the war in Ukraine, the weak outlook for the eurozone economy because of energy supply disruptions, and weak demand from overseas,” he says. “The eurozone trade balance has swung into deficit because of the sharp deterioration in the terms of trade and faltering growth especially in China, its largest trade partner.”
Euro’s woes
Broux suggests it is difficult to see the euro rebound without a resolution of the energy crisis, a recovery in Chinese growth and an end to the tightening rate cycle in the US. Demand for dollar liquidity before year-end and populist spending plans by the new government in Italy could further exacerbate the euro’s woes.
We are going through such a phase right now and more FX intervention is possible if the dollar stays strong in the closing months of 2022
Kenneth Broux, Societe Generale
The China factor is also weighing heavily on the Aussie, which correlates closely with the yuan and the performance of emerging market equity indices more broadly. “AUD will stay cheap as long as optimism does not return over the outlook for growth in China, and the policy rate differential with the US keeps widening,” says Broux.
He agrees that NOK and SEK could also struggle if broader market volatility stays elevated, noting that these are the currencies that typically suffer when demand for liquidity is high and investors scale down risk positions. “We are going through such a phase right now and more FX intervention is possible if the dollar stays strong in the closing months of 2022,” says Broux.
Thanos Vamvakidis, global head of G10 FX strategy at Bank of America, believes fiscal issues will become a key theme next year.
“Most advanced economies have very loose fiscal policies and it is misleading to compare fiscal policy today with that of two years ago, as it appears tight just because pandemic measures have expired,” he says. “Despite historically high nominal GDP growth and the surge of inflation, most countries still have deficits. They have not allowed automatic stabilizers to operate and have spent the one-off [post-pandemic] revenue windfall.”
Forced austerity
As nominal GDP growth starts falling next year, fiscal imbalances will become more obvious and some countries may be forced to implement austerity at the worst possible time – as they enter into recession.
Adam Button, chief currency analyst at ForexLive, reckons what has happened in the UK is a message to governments everywhere that the era of free money is over.
“Shelve the plans for stimulus, support or new programmes, and prepare to pay down deficits much more quickly than planned or risk a UK-like disaster,” he says. “It may take more than the example of one country for governments to get the message, but they eventually will.”
The situation in the UK provides a strong message not to push the envelope too far as the consequences could be costly
Paul Mackel, HSBC
However, Citi’s Gkionakis suggests the experience of the UK does not argue either against stimulus or in favour of austerity, and that it is the starting point and the nature of fiscal policy that matter.
“The UK’s starting point was one of high debt and an explosive current-account deficit, both of which can be detrimental when confronting the market with higher borrowing,” he says, adding that the government’s plan did not provide targeted support or aim to expand the supply side of the economy.
Interactive Brokers senior economist José Torres observes: “The Bank of England’s resolve will be tested further in the coming months and the world will be watching to see if central banks stay true to the inflation fight or buckle amidst market volatility and weaker economic performance.”
Mackel at HSBC agrees that the experience of the UK will not necessarily persuade other developed countries to shelve stimulus plans in favour of austerity programmes, but accepts that it is likely to be a wake-up call that the bond vigilantes are a leading force in financial markets.
“The situation in the UK provides a strong message not to push the envelope too far as the consequences could be costly,” he says. “But some governments will still want to push ahead with fiscal loosening to offset the impact of high energy prices and the cost to real incomes for households and corporates.”
