Forex trading was “pretty simple” between 2002 and 2007, says Buttonwood in The Economist. Investors earned easy money by borrowing in currencies with low yields then parking the money in currencies and assets with high yields. But now the slump in riskier assets has negated gains on the interest differential, and with interest rates in the major economies all low, the ‘carry trade’ is no longer the major focus. “The new world of foreign exchange” looks “much more complicated”.
One new theme is the “credibility of economic policy”, says Buttonwood. According to Adam Cole of the Royal Bank of Canada, the US authorities have done everything they can to boost growth, including quantitative easing, while their continental European counterparts have been more cautious. This helps explain why the dollar has done well against the euro. High budget deficits and printing money would normally weaken a currency, but for now it seems traders are putting aside such doubts and hoping unorthodox measures work. Investors are also keeping an eye on current-account deficits. America’s deficit is rapidly shrinking, which bodes well for the dollar for now, reckons Bank of America-Merrill Lynch.
The abiding theme in currency markets at the moment, however, is still the ebbs and flows of risk appetite. When this rises, as it has of late, equities gain, traditional safe havens such the dollar and the yen weaken, while everything else improves, says David Watt of RBC Capital Markets. The pound is now at a four-month high against the greenback, for instance, while the yen is at a six-month low against the high-yielding Australian dollar as interest in carry trades has revived with risk appetite.
Given all this, forecasting currency movements is even more of a mug’s game than usual. But the clear danger is that global markets have been jumping the gun as a sustained economic recovery is not yet assured, says Bank of America-Merrill Lynch. That, alongside America’s falling trade deficit, suggests scope for the dollar to strengthen again in the near-term. The worst of the pound’s slide may be behind it, but the red ink highlighted by the Budget could keep it subdued over the next few weeks, reckons Morgan Stanley. It sees the pound retreating to $1.39 by the end of June.