Central bankers drift further apart
Currency analysts always have opposing views, but they can agree on one thing: policy divergence is a theme that is set to continue in 2017. Central bankers in the US, Europe and the UK are taking increasingly divergent routes in their approach to monetary policy.
The US Federal Reserve raised interest rates in December for the second time in a decade – the first being almost exactly a year ago – and Fed chair Janet Yellen signalled that more rate rises are to come in 2017. The Federal Open Market Committee said it now anticipates three rate hikes next year, factoring an increase in spending.
Across the pond, it’s a different story. The European Central Bank has eased monetary policy by way of its nine-month quantitative easing extension, through to the end of 2017. It has also not ruled out further easing measures, in stark contrast to the rhetoric from US central bankers.
Meanwhile, the Bank of England has left rates on hold, after cutting them to record lows of 0.25% earlier this year following the Brexit vote. It also warned of higher inflation and slower wage growth. What does this mean for major currencies?
“The anticipated policy settings are in different phases of the policy cycle and favour the USD first, sterling second and the euro area third,” believes Brian Martin, analyst at ANZ Bank.
Société Générale is bullish on the dollar – macro strategist Kit Juckes says the French bank predicts it will continue to “drive higher” in the first half of 2017.
“We’ll likely see parity for EUR/USD and 120 for USD/JPY a lot sooner than expected, as usual,” he says.
The dollar has its naysayers though. It is becoming extremely overvalued, believes Lee Hardman, currency analyst at Bank of Tokyo-Mitsubishi UFJ.
The Japanese bank still believes there is scope for the greenback to strengthen further in the first half of 2017, but points out that the market is already discounting a marked step up in the pace of Fed tightening in coming years. The market has already started to factor in US rate hikes into the dollar.
Political fall-out dominated markets in 2016; market participants believe this is likely to continue. The impact of political elections, referendums and even statements cannot be underestimated, as evidenced by the impact of the Brexit vote on sterling.
The October flash crash in sterling was linked to comments around Brexit made by French president François Hollande, although the causes of the crash are yet to be determined. The beleaguered currency has recovered somewhat against other major currencies, but is still trailing below pre-Brexit levels.
FX moves up the agenda
2016 was the year that shook up currencies: sterling took a beating, while the dollar continued to march ahead. Levels of volatility were such that businesses sat up and took note, mindful of their bottom line, say hedging experts.
“The devaluation of the pound [had] a massive impact on UK companies,” says Alex Hunn, chief executive at peer-to-peer currency exchange freemarketFX. “That has forced them to review their [currency] policies.”
The rise in volatility has been a boon for low-cost currency exchange platforms, catering to businesses that need to transact FX as cheaply as possible.
FreemarketFX has doubled volumes every quarter, says Hunn, with regular repeat business from SMEs; active customers transact an average of £65,000 per month. The sudden devaluation in the pound means businesses are now “eking out value” when transacting FX.
“We saw an uplift [in trading volumes], without a shadow of a doubt,” says Hunn. “That devaluation had a massive impact on businesses that are exporting and with small margins.”
Automation in FX is a growing trend, believes Marek Fodor, chairman and head of marketing at FX management solutions provider Kantox. Corporate treasurers are responsible for hedging currency risk, which can increasingly be automated, he says.
“Now as more and more companies are selling abroad and markets are volatile, the next wave of treasury that should get automated is FX. We do for FX what a payments factory does for payments,” he says.
Some companies are more sophisticated than others in terms of hedging, but experts believe that more businesses are educating themselves about the impact of currency risk on their bottom line. Companies that previously might have never had a firm hedging policy in place are now implementing one, in light of currency volatility.
The fund management industry is also waking up to customized solutions, such as proprietary in-house systems or those provided by third-party specialist providers. Validus Risk Management conducted a survey of fund managers in the alternative investment industry, to analyse how they manage currency risk.
Sixty-two funds managing more than $500 billion were surveyed: half are still using Excel to identify risk and monitor hedging performance, while more than a quarter (27%) use third-party risk solutions or an in-house system. Nearly a quarter (23%) don’t use any system at all.
However, fund managers are changing their approach, says Validus Risk Management, with the year-on-year trend showing a move towards more customized solutions.
The report says: “The reasons given for this migration include mitigating risk of human error, increasing flexibility to present monitoring and analysis in more intuitive/customized ways, and the need for more robust solutions in general.
“This trend is not surprising given that other more mature asset classes have taken this path some time ago.”
The aftermath of the currency scandal will still be felt in 2017. Mark Johnson and Stuart Scott are set to face trial in September 2017; they have been charged with conspiracy and wire fraud over allegedly front-running a multi-billion dollar currency deal. The former HSBC currency heads face up to 30 years in jail if found guilty.
Meanwhile, fired currency traders are still fighting back. Baris Ozkaptan is the latest trader waiting to hear if he has won his fight against Citi; his hearing ended in November and a decision is expected early 2017.
Market participants are hoping that when the second half of the new global code of conduct is released in 2017, it will spell the beginning of a new phase in FX.
“I am a big fan of the code; it is worthwhile undertaking,” says Tod Van Name, global head of FX and commodities electronic trading at Bloomberg.
“Next year you may find some firms only transact business with firms [that have] accepted this code,” he says.
“I wouldn’t be surprised if firms refuse to deal with firms that don’t ascribe to the code. If we as FX professionals want to remain unregulated in many respects, we are going to have to self-police.”