Date: 04 Oct 2018
The American economy is undeniably taking the lead in relation to other G20 countries. Unemployment at a historical low of 4%, GDP growth above 4% and inflation approaching 3%. The vitality of the economy is matched by the FED’s monetary policy, with 3 interest rate rises so far this year and one more lined up for December. Galloping American numbers, especially remarkable when compared with the Eurozone figures; GDP growth barely touching 0.5% thus far, unemployment sitting above 8% and 2% inflation. The more optimistic observers estimate that the ECB will start tightening monetary policy by raising interest rates only in the second half of 2019.
If the output of the two economies explains the divergence in central bank monetary policies, it’s also clear that the impact can be felt on the performance of the respective currencies. At the time of writing, the dollar is outperforming the euro at the pace of 2.8% so far, this year. The Greenback assumed the role of refuge asset during 2018, for reasons already mentioned, but also because other traditionally sought safe havens lost appeal. Consider gold, for example. The precious metal is down by more than 8% since the beginning of the year. Why is it so? Well, here’ a clue: American Treasuries. The 10-year title currently yields above 3% returns, and this, at least in part, is why gold has lost some of its appeal.
But the divergence in monetary policies is not only reflected on the performance of currencies and metals. There are other winners and losers. US stocks are the star performers, benefiting from extraordinary conditions, described by some as Goldilocks, for equity traders. So far in 2018, the S&P is up by more than 9%, Nasdaq 18% and the Dow more than 7%. On the losing side, we find EM economies. Argentina and Turkey more markedly, but others with large foreign denominated debt and high current account deficit are also feeling the impact of a strong dollar. The flows have been unidirectional, the effects are weighing down the prospects of growth and threatening a domino effect, as the markets smell blood.
Will 2019 be a continuation of the current state of the affairs, or will we see a turn? Will American growth slow down, or even come to a standstill? And, if so, will the Fed’s monetary policy become more dovish, or would it maintain the hawkish stance to curb inflation? Could the Euro become the new safe haven? Are EM markets undervalued, and if yes, will investors realise that and alter the direction of the flows?
It may sound far-fetched now. But the markets react quickly and can just as easily adapt to a new reality. What if the current trade tensions escalate into a trade war? American consumers will start feeling the heat because of higher prices; industry will suffer supply chain disruption, and rising prices would be accompanied by higher interest rates and slow or no growth. Many believe that the fiscal stimulus, which proved to be such a powerful boost to growth came too early in the cycle and the US administration is failing to keep the powder dry for when it may be needed.
Consider this scenario: If European geopolitical issues (rise of populism, Italian budget, Brexit, etc.) fizzle out in 2019. The ECB’s monetary policy tightening starts and coincides with a lacklustre North American period. We could be looking at a significant change in dynamics and considerable movement on the Euro-Dollar pair with the Greenback under selling pressure.
Could now be the time to start bidding the euro?
By Ricardo Evangelista, Senior Analyst, ActivTrades
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