The pending summer holiday period gives us time to reflect on the year so far and the opportunity to recharge our batteries for what is expected to be a busy Q4. If you cast your mind back to the last Christmas holiday period, we had the ECB deciding to halt its quantitative easing programme of bond purchases after spending 2.5 trillion Euros and we were expecting further rate hikes from the US into 2019.
As is often the case tides turn quickly in the financial markets. Last week Draghi chose “talk over action” in terms of loosening policy. He reiterated that he did not like the current rate of inflation and was studying ways to restart the ECB’s bond buying stimulus.
This week a rate cut from the US is highly anticipated. There has been talk of the need for a 50bps rate cut for a while. However, over the last couple of weeks the economic data releases from the US have reduced the likelihood of this happening to 15%. So, a 25bps cut looks almost like a done deal with an 85% probability. Q2 GDP showed growth in the US slow to 2.1% but consumer spending remained robust, hardly warranting aggressive loosening.
Further afield we have seen far more dramatic shifts in interest rates. Australia for example has normally been considered to have a currency with an attractive yield. This is no longer the case and we were reminded of this by RBA Governor Lowe last week when he threatened further loosening of monetary policy with rates possibly heading as low as 0.5% into 2020. This follows consecutive interest rate cuts in June and July leaving rates at an unprecedented 1%.
With rates in the US currently at 2.25%-2.50% the consequences for the costs of hedging Australian assets by US dollar funds over the past decade have been seismic. In 2011 the cost to hedge the Australian dollar back to the US dollar in terms of forward points was just over 5%. That was certainly enough of a cost to take into consideration when looking at Australian assets. Currently to hedge the Australian dollar for a year that 5% cost has been replaced by a 1% benefit. A 6% swing and potentially an easier decision now.
Back in the UK the interest rate outlook is pretty tame and no action is expected this week at the Bank of England meeting. Donald Trump has often referred to countries using interest rate policy to manipulate their currencies to make them more competitive. Currently we do not need this as Brexit continues to weigh on the currency with GBP/USD plumbing a 27-month low at 1.2380 last week. With Boris Johnson promising that Brexit will take place on October 31st “do or die”, the potential risk of a hard Brexit increases and so does the downward pressure on Sterling.
Upcoming Economic Releases
On the economic data front the highlights for this week will be the aforementioned FOMC rate decision and on Friday the non-farm payrolls. In the UK it will be the quarterly inflation report and from Europe it will be the manufacturing PMI data.
For more information, please contact Chris Towner, Director at Chatham, at email@example.com.