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Forex Forecasts: A Rare Long-Term View
By: Martin Tillier
When I worked in London's interbank Foreign Exchange market, the Holiday season would usually make me smile. Not the season itself, although the excessive celebration was fun, but the people I would meet during the inevitable round of social parties. Often, once people found out what I did for a living, they'd ask me a question which usually went something like "I'm going on vacation in six months, should I buy my currency now or later?"
I would mutter under my breath, and then point out that I was a spot guy, meaning that I was paid to know where a currency pair was going in the next six seconds or minutes, not months. Most would press for an answer, however, somehow convinced that fluctuations in the exchange rate they got for their $1000 of spending money would matter to me. I am ashamed to admit that I would make up a long term view on the spot. I really had no idea what long term moves in currencies would look like, and knew I'd be right 50% of the time.
Now, however, as one who writes about markets, I have to take a longer term, more general view and, as all of my articles are subject to public scrutiny and archived, making something up doesn't cut it. I still find it difficult to form a long term view on currency markets most of the time, however, but this year, I actually have one. With that in mind, let's take a look at the prospects for two major currency pairs, the US Dollar against the Japanese Yen (USD/JPY) and the Euro against the US Dollar (EUR/USD) in 2014.
Central Bank distortion around the world has been the overriding influence on the forex market throughout this year and will likely continue to be so in 2014. Interest rates are the single biggest fundamental driver of currency markets and they are set by Central Banks, but that is not what I am talking about. That traditional aspect of monetary policy doesn't count to me as distortion; messing with the supply of a currency, however, does. I am not concerned here with the desirability or otherwise of Central Banks expanding their balance sheets, but rather the effects of that policy.
The biggest of all distortions has been the Federal Reserve Bank's QE policy, but the BOJ's efforts were a large part of the theme for 2013. Back in March, when Dollar Yen (USD/JPY) was around 92.50, I wrote that basically, nothing had changed and the upward march was set to continue.
There are technical and market positioning factors that lead me to believe that the current move back up to challenge 105 may lead to a short term correction back to around, or even below, 100, but long term there is no reason USD/JPY cannot continue its march up.
The BOJ and the Japanese government have renewed their commitment to Abenomics, and will continue with their expanded asset purchase (QE) program. The Fed, meanwhile, has begun to taper. In other words, Yen supply will continue to be increased at the same rate, while the rate of supply increase of US Dollars is being reduced. You don't have to be a Nobel Prize winning economist to understand that if supply of A is increasing relative to supply of B then the value of A will fall relative to B. In other words, the Yen will lose value against the Dollar. Of course, the Fed has also committed to maintaining an ultra-low interest rate policy for the foreseeable future, but then so has Japan. It is reasonable, therefore, to expect continued strength in USD/JPY in the coming year.
The US Dollar has not, however, spent all year gaining ground against other currencies as the prospect of tapering arrived. As you can see from the chart above, EUR/USD has spent the second half of 2013 moving rapidly up from lows around 1.28 to challenge the 1.38 level. (Because the Euro is the first named currency in this pair, a higher rate indicates a lower Dollar).
Largely this has been down to improving economic conditions in Europe and that trend could well continue, but even so, I think EUR/USD will close 2014 at lower levels that we see now. Economic conditions are also improving here in the US, so that factor is probably a wash and supply matters will once again dominate.
While the ECB is engaged in an internal battle regarding whether further loosening of monetary policy is the best move, the Fed has begun on the long road towards tightening, so Dollar strength, and therefore a lower EUR/USD is the natural result.
Against both the Yen and the Euro, then, I expect Dollar strength to be the theme of 2014. That doesn't mean, however, that the greenback will appreciate against everything. Earlier this year, I doubted the recovery in the UK to some extent (forgive me, oh fellow countrymen!) but I was wrong. The mini-boom there could well continue, with resulting Sterling strength.
It would also come as no surprise to see some embattled emerging market currencies recovering against the Dollar, even in a year of tapering and with a continued recovery in the US as global demand for commodities increases and the slightly lower growth rate in China becomes the norm.
Years ago, this long term view thing when it came to foreign exchange was, in my eyes a waste of time; a pointless exercise. Now, however, as I use forex as much to influence overall positioning as I do as a trading instrument, developing a six to twelve month overall view has become important. If you do see me at a New Year's party, then, feel free to come and ask my opinion. If the question is about forex, I promise not to be flippant and make things up. Of course, if you ask my opinion of your family, politics or almost any other subject, I can make no such promise.