FX FUNDAMENTAL ANALYSIS Chart 3 - Central Bank balance sheets with the Dollar, global reserves and the US current account
economy and financial markets would have been under severe strain since 2014. Indeed, a couple of times, specifically August 2015 and January 2016 did witness a sharp financial market sell off and worries over economic growth. However, seeming powerful forces came to the rescue both times. Indeed, it is these forces that have continued to encourage risk taking and done enough to keep the economy from keeling over. We would add here that the headwind from FX reserves should continue in the months ahead in our opinion.
As is clear since 2014, whereas the Fed began to taper and finally ended QE in very late 2014, the ECB and BoJ have been running the
printing presses pretty hot
24/7. Furthermore, just as the Fed seemed intent on raising interest rates, they eased back in September 2015 (just as the world seemed to be ending) and moved from forecasting four rate rises this year to actually only raising rates once.
What seems clear since 2014 is that central banks have promised to co-ordinate policy on the dovish side. Ok, the Fed did end QE and have nudged rates up a couple of times, but when it really mattered (when markets were on the edge of the abyss), they talked extremely dovishly. And all
the
while, courtesy of ECB and BoJ QE (with a little help from the Swiss National Bank and close friends), global QE as measured in monthly
Dollar totals has never been higher. So simplistically (and something we all know to be true), global central banks have coordinated policy in the last two years at an ultra-accommodative setting and this has prevented any major financial market disturbances and been sufficient to keep the global economy ticking over. Indeed, post the January 2016 market wobble, there was talk of a Shanghai accord at the G20 in February. At the time, policymakers globally were extremely concerned about the strength of the Dollar and coordinated policy to weaken it. Namely the Fed rowed back on predictions of four rates rises and the ECB and BoJ stepped up there easing programmes. Without this co-ordination to cap the Dollar’s strength, we think the
financial markets could well have suffered much greater losses.
Fast forward to today, and it appears that we are very much back between a rock and a hard place. The Dollar is strengthening (not only because of policy divergence but also because of potential policy changes under the new administration) and this is going to increase strains in the system. Having only just raised expectations for rate rises and confirmed that she does not want to run a “high pressure [economy] as an experiment”, Janet Yellen cannot risk the Fed’s credibility by reversing course again, especially if Trump’s reflationary
36 FX TRADER MAGAZINE January - March 2017
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