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In a world filled with plenty of uncertainties, the almost $7 trillion-a-day currency market is being seen as perhaps the best venue for trading the diverging policy paths of central banks worldwide in the pandemic’s delta era.
Friday’s weaker-than-expected U.S. jobs report for August kept alive expectations of a Federal Reserve announcement to taper bond purchases this year, but raised plenty of questions about the strength of the economy. That doubt put downward pressure on the U.S. dollar at a time when uncertainties about the coronavirus delta variant and its impact on global economic growth remain high.
Currency players– who are, by nature, acutely aware of what’s happening every day, everywhere around the globe — are used to occasional periods of short-term uncertainty, in which they assess which regions will hold up better than others. What’s unique this time around is that the lack of clarity comes as central banks worldwide are intent on unwinding roughly 18 months of extraordinary stimulus — albeit in a less-than-uniform way.
“The variant has created more unknowns and an environment that we are not used to,” said Hans Jacob Feder, global head of FX services at MUFG Investor Services based in London. “When and how we recover are some of the questions being asked, and there’s a lot of hypothesizing about what will happen next. How to interpret data before COVID-19 was easier. Now it’s not so clear, with people switching views faster. In FX, there’s probably going to be quite a bit of volatility.”
Even if volatility picks up going forward, the global currency market — which operates around the clock– is still perhaps the premiere way to find huge trading opportunities, some say. Markets such as bonds, investment-grade credit, and even stocks are all priced for “benign” economic outcomes, whereas the currency market “is in a state of flux” around the delta variant — exposing advantages in certain parts of the globe, according to Oliver Williams, an emerging-market debt portfolio manager at Insight Investment, which manages more than $1 trillion.
A lot of the currency market’s state of flux has to do with the various stages that countries are in when it comes to vaccinating their populations, on top of the diverging paths which central banks are taking with regard to pulling back on stimulus and hiking interest rates again. The Fed, for instance, is taking a relatively slower approach to tightening policy given a need to assess labor-market improvement. Central banks more squarely focused on inflation, like Mexico’s, have raised interest rates with greater urgency.
“Central banks are all moving at a varying pace, but with more conviction about reversing policy,” said Mazen Issa, a senior currency strategist at TD Securities. “Emerging markets are further along in the policy-tightening cycle, and that’s lent itself to some EM currencies performing well. But Fed policy may be about to change, and those dynamics could become more fluid.”
With inflation continuing to remain elevated globally, emerging markets are where pressures unleashed by the pandemic are likely to be amplified and central banks have been most likely to hike.
A case in point: When Chile’s central bank doubled its key overnight interest rate on Aug. 31, the Chilean peso
CLPUSD,
hit a one-month high the next day. A decision by Brazil to hike rates in August — in order to tame inflation — gave a short-term boost to the real
BRLUSD,
though a move by Mexico last month failed to trigger a bullish reaction in the peso
MXNUSD,
Meanwhile, Russia’s rate increase in July gave a modest lift to the ruble
RUBUSD,
in the days that followed.
Conversely, in the small but developed country of New Zealand, an unexpected delay of a widely expected rate hike last month — as the result of a pandemic-induced lockdown — caused a sudden drop in the kiwi
NZDUSD,
before it recouped.
The U.S. dollar
DXY,
has more or less held steady since mid-June, around the time when Fed officials dived into a debate on slowing their bond purchases — the prerequisite step toward hiking. Meanwhile, the euro
EURUSD,
is flat against the dollar over the same period, with investors betting that European Central Bank policy makers will also be tapering, possibly this year.
Read: European bond yields rise on ECB tapering bets
“Everyone is waiting to get some clarity around the pace of tapering by the Fed,” Insight Investment’s Williams said via phone from London.
Emerging-market countries like Brazil, India, Indonesia, South Africa and Turkey, he says, “can weather a tapering surprise better than they did in 2013” — when talk of pulling back on bond purchases by former Fed Chairman Ben Bernanke led to a sudden spike in long-term Treasury yields.
Insight Investment moved into long positions on the Turkish lira
TRYUSD,
and the Brazilian real in the middle of this year, and also likes the Peruvian sol and Colombian peso
COPUSD,
according to Williams. All four currencies are “cheap” relative to long-term valuation metrics and exchange rates, and emerging-market currencies generally offer far more investment opportunities than advanced economies, like the U.S. and Europe, where inflation could dissipate without sweeping monetary-policy reversals.
The firm remains cautious about most Asian currencies, with the exception of the Indian rupee
INRUSD,
on the view that the region’s tendency to lockdown economies due to the delta variant will hit growth, the portfolio manager said.
“The pandemic was a great equalizer,” said Amarjit Sahota, a currency strategist and executive director of foreign-exchange services provider Klarity FX in San Francisco. “Everyone was impacted and now you’re seeing different responses to the removal of policies, based on which economies have come out the fastest.”
Shortened week ahead
Financial markets ended the week with U.S. stock indexes mixed, with the Nasdaq Composite Index
COMP,
booking its 35th record close of 2021 and the S&P 500
SPX,
and Dow Jones Industrial Average
DJIA,
limping lower. Most yields edged higher on Friday, with the 10- and 30-year rates having their biggest two-week rise in months, as bond traders focused on bright spots in August’s jobs data.
Given the U.S. Labor Day holiday on Monday, the abbreviated week ahead in the U.S. contains a lack of major data that might matter to currency traders. Wednesday brings July job openings and the Fed’s Beige Book report. Weekly jobless claims are released on Thursday, while the August producer price index is due on Frilday. The Kroger Co.
KR,
is the only S&P 500 company reporting earnings next week.
