FX volatility ahead as central banks walk tightrope
They are trying to pull off a soft landing, hiking interest rates to slow inflation without tipping their economies into recession. It's a near impossible task, according to former US Treasury Secretary Larry Summers, who found that since 1955 in the US, there has never been a quarter with price inflation above 4% and unemployment below 5% that was not followed by a US recession within the next two years.1 To get more news about DBG Markets盾博, you can visit wikifx.com official website.
Six months ago, commentators were calling on US Federal Reserve Chairman Jerome Powell to stave off surging inflation with interest rate rises. Back then, he, and other central bank policymakers, asserted that inflation was a transitory phenomenon caused by COVID-19 lockdowns, and a release of pent up consumer demand. But inflation readings remained stubborn and with other factors like the war in Ukraine driving up food and fuel prices, central banks have had to jack up interest rates hard and fast to prevent prices from spiralling out of control.2
The 1.5% rise in US interest rates so far this year seems to be biting much harder than many had predicted, with the Atlanta branch of the US Federal Reserve forecasting a 2.1% drop in GDP for the second quarter. That would be on top of the 1.6% contraction in the first three months of 2022.
That's a forecast, rather than official data, but if accurate it would meet one criteria for calling a recession - two consecutive quarters of negative growth.
As seen in 2008, if the US does start to tip into a recession, it is likely that other countries may follow and effectively managing currency risk in this environment would be increasingly important.
In June, the World Bank issued its 176 page economic analysis - Global Economic Prospects. It made for ugly reading. The bank slashed its forecast for global growth from 5.7% in 2021 to 2.9% this year, the sharpest deceleration in a post-recession recovery in 80 years. And there wasn't any sugar coating about the future in the report's second paragraph;
"Amid the war in Ukraine, surging inflation, and rising interest rates, global economic growth is expected to slump in 2022. Several years of above-average inflation and below-average growth are now likely, with potentially destabilizing consequences for low- and middle-income economies. It's a phenomenon-stagflation-that the world has not seen since the 1970s."With the three major drivers of the global economy all showing signs of slowing, the global outlook is becoming more uncertain. In a switch to risk-off sentiment, financial markets are on high alert. US equities, sold off in times of economic shock and uncertainty, had their worst start to a year since 1962 with the Dow Jones down by 21%, SP 500 down 20.6% by June end. The Nasdaq's fall of 29% year to date is its worst ever.
US government bond yields are another sign of a spooked market. Bond yields move in inverse relation to prices. The benchmark US 10-year Treasury yield dropped to its lowest level since May as investors sought the safety of US government bonds, driving up bond prices.12
The US dollar has already been rallying thanks to the more hawkish (aggressive) tone set by the US Federal Reserve on interest rates. Now global slowdown fears are adding momentum to the dollar's upward trajectory as investors look to the US dollar as a safe haven currency in the event of a slowdown. So far the dollar has had its best start to the year since 2010 according to the Wall Street Journal's Dollar Index, increasing 8.7% against a basket of 16 currencies.13
Other currencies, like the euro, are struggling. The war in Ukraine has meant the prospects for the eurozone are less certain. Interest rate hikes, while coming, have not yet eventuated, muting demand for the currency as investors look to higher-yielding currencies for better returns. The euro is down 7.5% against the dollar so far this year.
The Japanese yen is another safe haven currency in times of stress but here particularly the ultra-accommodative monetary policy is having a strong impact. While the Fed has been steadily raising rates, the Bank of Japan has been opting to wait and see. The width of that interest rate differential has helped the US dollar soar 18% against the yen this year.
Slow or backward global growth is bad news for commodity currencies such as the Australian dollar and New Zealand dollar, which are closely linked to demand for key exports. These currencies are already being sold off based on the fear of global recession, both hitting 2-year lows in July.