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One big theme influencing the currency market this year has been the disruption in commodity flows from Russia (due to the Ukraine war) and the damage caused to the European economy. This has made the European Central Bank (ECB) disinclined to raise interest rates out of concern a recession may be sparked, according to Georgette Boele of ANB Amro Bank. West of the Atlantic, the US Federal Reserve raised benchmark interest rates by 25 basis points in March, with an expected continuation of the trend in Fed meeting to come. The conflict took away traders’ risk appetite, and the dollar “Tends to outperform when the US economy is outpacing others as well as when risk aversion is high”, says Salman Baig of Unigestion SA. To get a better sense of the markets, let’s look at the key drivers behind three of the most traded currency pairs on the forex market.
When the year was beginning, the value of the US dollar relative to the Japanese yen was steadily being pushed up by expectations of Fed hawkishness, on the one hand, and the impression that the Bank of Japan was not planning to hike rates any time soon, on the other. On January 5th, the yen dropped to its lowest in five years, (with the USD/JPY at 116.35) and yet, Brent Donnelly of Spectra Markets advised against getting excited about the bullish signs for the dollar because “The big question remains: Can the Fed hike more than a few times without breaking everything?”, that is, without causing a recession.
What followed was a period of swift losses for the yen, with the USD/JPY hitting 128 on April 19th, and finance minister Shunichi Suzuki feeling the pressure to raise rates but only insisting he was watching the situation “With a strong sense of vigilance”, and without making any concrete moves. This was despite the higher import costs faced by Japanese companies as a result of the currency slide, which were turning into a formidable business obstacle. At the end of the month, the yen completed a seven-week losing streak amounting to 11% and leaving it at 130 to the dollar. One point to note is that, although the yen is often viewed as a safe haven currency, traders were not attracted to it in these times of war, which may “Reflect a weakening of the Japanese economy”, in the words of Taku Ito of Nissay Asset Management.
March saw European currencies like the euro, the Swedish krona, and the British pound slide due to the economic fallout in Europe from commodity disruptions. When the calendar ticked over to April, Russia promised they would ease back their assault on Kyiv, prompting JPMorgan to see “Some of the more extreme tail risk scenarios reducing in probability”. Indeed, on April 1st, with EUR/USD at 1.1152, the dollar was at its lowest against the euro in two weeks and, adding to this, came a report of alarming inflation rates in Europe. “The euro was slightly appreciating before inflation readings for March but got an additional boost upon their arrival”, explained Derek Holt of Scotiabank Economics. High inflation rates mean the ECB will feel pressure to raise interest rates, which could elevate the euro.
The rest of April did not follow suit, however, and the euro ended the month lower against the dollar than it had been since 2017, with the EUR/USD at 1.0534 on April 27th. Russia’s decision to cut off gas supplies to Poland and Bulgaria had “[put] more pressure on the euro and accelerated the move to… potentially 0.85-0.9 by the end of this year,” explained Clifton Hill of Acadian Asset Management. Traders were drawn to the dollar’s safe haven appeal and expected half-point rate hikes from the next three Fed meetings, which supported the dollar.
At the beginning of March, retail inflation in the UK was at the uncomfortable figure of 8%, and rising commodity prices due to Russian sanctions were poised to push up the number even more. The Bank of England had already hiked interest rates by 40 basis points, but inflation had not sufficiently improved. The dollar was getting support from real yields and from expectations of Fed hawkishness, so that the British pound was down 1% against the American currency for the year.
On April 25th, the pound fell another 1% so that the GBP/USD was at 1.27, and analyst Stephen Barrow predicted it would continue to fall to leave the pair at 1.20-1.25 in coming months. Barrow noted that Brexit had worsened the impact of inflation on the UK as compared with elsewhere. The International Monetary Fund (IMF) even called UK inflation the “Worst of the two worlds”, meaning that the region was suffering both from an energy crunch and a pressured labor market.
Looking forward, it seems all major forex pairs are facing a period of volatility due to geopolitical conflicts that, at the moment, have no end in sight.
For forex traders, this means being diligent on both fundamental and technical analysis, getting all the facts and making precisely informed trading decisions.