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Quarterly market summary: October 2015

 

Pound takes a breather

The pound had a strong run in the first half of 2015, but it has started to slow in the last quarter. Economic data has been disappointing, especially from the manufacturing sector (in part because of the stronger pound).

Inflation has once again slipped back into negative territory for September, and back in April it fell below zero for the first time in 50 years. The combination of mixed data and concern about the slow down in global growth has led to a marked push back in the expected timing of a UK rate rise. As it stands we are looking to the middle of next year at the earliest, and some analysts are looking to 2017 for lift off.

Understandably, this has weakened the appetite for pounds. It is not all bad news, though – some data points are looking promising. For example, unemployment is holding at low levels and, crucially, earnings are still rising. This means that, at the moment, the UK is experiencing a bit of “joyflation” i.e. inflation is falling, wages are rising, and the economy is growing. Lower inflation is being attributed to falling commodities and fuel prices, and the sentiment is that this should turn around in the next six months. Assuming this sentiment is correct, we could see the pound waking from its slumber.


Euro could be under pressure in months to come

As has become typical in the run-up to a central bank policy shift, we’re being treated to a prolonged period of anticipation and debate which, in turn, drives the associated currency. This is true for the euro, and the ongoing “will they or won’t they” speculation on rate rises is adding more stimulus to the European Central Bank’s (ECB) asset purchase programme. The reasons for further stimulus are mainly falling inflation and the slow down in global activity, which will drag on the European recovery.

The Volkswagen scandal has certainly not helped, and could also damage German growth. The ECB has a few options for increasing stimulus. It could: cut interest rates further into negative territory; add more volume to the existing programme by increasing the value of monthly purchases; or extend the programme beyond the September timeline provided.The last option is probably the most likely one, and should see the euro come under further pressure in the currency markets after a respite in the last month.

 

Fed still taking its sweet time with rate rises

US dollar trading remains in the vice-like grip of the US Federal Reserve. The Greenback performed strongly during most of the quarter, as traders bought dollars in expectation of the US central bank starting to raise interest rates in September. But further dovishness from the Federal Open Market Committee is now driving the dollar back to where we started in July.

The Federal Reserve’s change of heart stemmed from worries about the global economy – specifically China, where growth has slowed over the last two years as Chinese authorities attempt to steer the economy from investment-led to consumer-led. This is a bit like turning around a cargo ship: it can be done, but it takes a great deal of time and skill.

So far in 2015, we’ve seen a huge stock market bubble inflate and then pop, plus a major devaluation of the renminbi against the US dollar. Small wonder, then, that volatility across the financial markets has been high.

The Federal Reserve’s worry is that raising interest rates in such an environment would lead to further market dislocations, so it is pushing back the expected date of rate rises. March 2016 is now the markets’ best guess, but don’t be surprised if we don’t see anything from the Fed next year. For the dollar, that means the current relative strength against the pound and the euro is probably overdone. We can expect further dollar weakness as we head in to Christmas.

 

Emerging markets and commodities-based currencies brace themselves

Emerging market (EM) and commodities-based currencies will be closely tracking both developments in China and the US’s clues to its rate rise. The equity fallout from China heavily affected EM and commodities-based currencies, and the general consensus is that Chinese economic growth will continue to slow.

We’ve recently seen some recovery in these currencies from their low points, but the markets will have their daggers sharpened and ready for any signs of more Chinese weakness. In addition, a US rate rise is likely to hit EM and commodities-based currencies hard.


 

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