Contributed by David Johnson
Commercial foreign exchange dealer
Halo Financial Ltd
OF ALL the market moving data, the expectations for interest rate adjustments are the most influential at the moment.
International investors are shuffling their so-called ‘hot money’ around the globe, looking for the highest yield possible with the minimum of currency market risk. This is creating some interesting waves in exchange rates. The currencies, which are weak as a result of these flows, are the lowest yielding. The Swiss Franc, with 1.75 per cent average interest rates, and the Yen, with a 0.25 per cent base rate, are understandably being used as sources for borrowing, with the funds raised through these sources being routed through to the high yielders like the New Zealand Dollar, as well as the economies where interest rates are forecast to rise.
Among these targets, the Euro and Pound are seeing very strong inflows, while the US Dollar, which has been a target for these kinds of investment flows over the past decade, is starting to lose its lustre, due to the halt in the upward slope of US interest rates.
An odd thing is happening: American investment houses, if not the individual investors, are discovering that there is a world outside the US and are shifting funds into Europe and even further east in growing numbers. The halt in the upward direction of US interest rates and a number of slowing economic indicators, particularly in housing and consumer related indices have contributed to this search for better returns and, having exhausted the onshore options, US hedge funds have begun to look to the east.
The Dollar had also declined due to rumours that the likes of the Peoples Bank of China (PBOC) and the central banks in the United Arab Emirates have been shedding US Dollars from their reserve holding, in favour of Euros and Malaysian Ringgits, among others. Recent comments from the PBOC suggest that, if they were divesting themselves of Dollars, they have done enough for now, so the slide in the Dollar may halt.
So, if US investors are dumping their Dollars in favour of overseas interest rate products, they will need to know what the prospects for the Eurozone and UK interest rates are.
Well, while the recent Blair/Brown politicking has only marginally damaged the Pound, the prospects for another interest rate hike from the Bank of England (BOE) received a solid boost when August inflation rose to 2.5 per cent. This is 0.5 per cent above the BOE target rate, but it does remain in line with the BOE’s own forecasts. However, the addition of strong housing data and expanding consumer credit may force the hand of the BOE.
Most analysts were convinced that the BOE would leave the UK base rate well alone for the latter part of 2006, but that is now being called into question, and the future markets have prices in another 0.25 per cent interest rate hike before November.
The picture is just as mixed in Europe, where the Eurozone interest rate could also rise before November, but where the reasons for another rise are less forceful.
The European Central Bank (ECB) does make a case for remaining vigilant on inflation, but other than a meagre rise in output, a marginal drop in unemployment and mixed levels of inflation, there are few irrefutable arguments for an interest rate hike. Nevertheless, traders are convinced that the ECB will act and October is the most likely date for another 0.25 per cent interest rate hike.
It would seem then that the Euro and the Pound are destined to remain strong for the rest of the year. Relatively high and rising interest rates would appear to be all the incentive international investors need to buy these two but, when you are trading between the two, either selling Euros for Pounds or vice versa, the only way to be certain of a sensible exchange rate is to use the inevitable volatility to your advantage.
Thankfully, international investors are a fickle bunch, and their actions create wide trading ranges; so those who physically have to convert funds can do so when the speculators have had their say.
I guess the moral to this story is that gambling does pay – as long as you are not the one doing the gambling.
David Johnson can be contacted on Tel. ++ 44 (0) 207 350 5470 or via e-mail at [email protected]