October 2015 FX market report. Uneasy lies the head that wears the crown. So wrote William Shakespeare in King Henry IV Part Two. So lies the task of the US Federal Reserve whose long-anticipated but still pending rate hike has been blamed for much of the recent volatility in financial markets. So as we examine the FX space this past month, we’ll begin at the end. On October 28, the Fed – as represented in a statement from the Federal Open Market Committee as opposed to myriad competing comments from various officials – declared that tightening may begin in December. Why? Because in the Fed’s view, global market tensions were now less of an issue.
What they had in mind was an unexpected cut from the PBOC earlier in the month, together with ECB Draghi’s guidance that further QE measures were on the table. As a result, the job of nursing the global economy with liquidity has now been passed eastward from the New York FOMC desk. These were the dominant events of this month that produced some divergent results for currencies. What is clear however is that the Fed’s threat seems to hold little fear for equities or bonds. Granted, US 10 year yields managed a 10bp increase for the month, while Bunds were unchanged. Equities did well, with the S&P and Nikkei gaining over 8pct. with Shanghai close behind, while the DAX jumped 12pct despite the VW scandal which threatens to engulf the company. To note also modest 2.5pct. increases in gold and crude.
But since this is a currency report let us return to the various outcomes in FX for October. Last month we suggested that the Fed would remain on hold and that there would seem to be an opportunity building in some of the most-hit emerging market pairs. We also suggested better times ahead for the Euro. While this letter is by no means offering investment advice, we are prepared to fall on our swords for bad calls while taking a modicum of credit for the better ones. So to the Euro. After registering its best level since the August 24 China-induced panic – gaining 3pct. to 1.1475 by mid-month it fell sharply on the aforementioned comments from Draghi, to never really recover, with the final blow coming late last week after the Fed’s comments. In all, EURUSD lost 1.5pct. The JPY and CHF had small losses also, but JPY seems to be struggling to weaken much beyond 121.00 given the BOJ has decided further easing is off the cards, which has not disturbed a strong recovery in the Nikkei, along with China, as mentioned.
Other currencies did much better however. Emerging and commodity pairs led, helped by the move in China. Leading was IDR up 6.5pct, NZD, up 6pct, KRW up 4.2pct and COP up 5.4pct. Other troubled EM pairs did well also, but with significant intra-month volatility. Here we can include BRL, TRY, RUB, and MYR. And a note on GBP which outshone its European neighbour to gain 2pct versus USD and 3.5pct against EUR. It is worth bearing in mind that negative bets on sterling based on a British opt-out of the EU (vote next October) may be misplaced. Europe still has many problems and they’ve been handed another one in the form of the stream of refugees which is an immense human tragedy that may well have negative implications for the current political leaders, beginning with Angela Merkel.
And so to the outlook. It is our view that the Fed will remain on hold for the balance of this year but this does not necessarily mean US rates will remain on the floor. There are other forces at work on the demand side of Treasury debt, notably the threat of reserve liquidations primarily from Middle East holders. The political, economic and human situation continues to deteriorate and surely must impact credit and debt markets. And even if and when the Fed begins to raise rates, the pressure to counteract from Asia and Europe may not always send the dollar higher. This is a story built on anticipation and not on fact.
With that we believe that there are still opportunities among the high-yielders as well as the more stable pairs such as GBPUSD, NZD and AUD. Currency markets are a reflection of the global puzzle. Watch for active year-end trading.