What next for the euro, yen and sterling?

The euro, the Japanese yen and the British pound exchange rate against the dollar are the most critical monetary equations in international finance. Federal Open Market Committee (FOMC) downgraded its growth forecast on the US economy, making it clear that the American central bank will do its utmost to avoid any change in its policy overnight borrowing rate for the next six months.

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Published: Mon 19 Jul 2010, 11:15 PM

Last updated: Mon 6 Apr 2015, 2:06 AM

Payrolls, retail sales, consumer confidence, auto sales, industrial production all suggest a US economic soft patch, not a double dip recession. The rise in the euro since its 1.18 low can no longer be dismissed as mere short covering, particularly since Spain successfully sold sovereign bonds at auction ahead of the European Central Bank’s (ECB) bank stress tests.

I would urge investors and traders to remember that dollar weakness, not euro strength, defines the global forex zeitgeist. Financial reform will have a seismic impact on global finance, as it increases the cost of hedging and capital for Wall Street’s banking colossi. It is even more significant that the euro has risen above 1.28 even though Chicago IMM data shows short positions have declined. Implied volatility curves in the euro have also fallen, as has the correlation to the risk on equities trade. However, I notice the correlation between the euro-dollar forex rate and the Uncle Sam-German Bund rate spread has risen. The next big test for the euro will be the German ZEW sentiment survey and the ECB bank stress tests. While these might trigger a pullback, I reiterate my call (made in this column a month ago when all global banks were warning us about euro/dollar parity) that the euro is headed to 1.30-1.34 in the next three months.

The Japanese yen is hypersensitive to the interest rate spread between the ten-year bellwether US Treasury note and JGB debt. With no hope of an imminent FOMC rate hike, it is only natural that the Japanese yen has surged to 88 even though global equities/risk assets are on a roll (i.e. this is no safe haven yen buying) and DPJ (Democratic Party of Japan) Prime Minister Naoto Kan, Mr Weak Yen, got hammered in the latest Upper House Diet elections. Changes in rules on margin trading in Tokyo has also triggered yen buying by retail investors short the high yield dollar bloc currencies, notably Canada and the Aussie Horrible US retail sales and PPI (Producer Price Index) data, a dovish FOMC minutes and the Chinese yuan mini-revaluation are all yen positive.

Can the cognoscenti of the Empire of the Rising Sun see echoes of Japan’s “lost decade” in America, where property is leprosy, millions of gullible home buyers were wiped out in the credit tsunami and zombie banks are propped up by tax-spend populist governments while prices fall in the deflation death spiral? Bank of Japan Governor Masaki Shirakawa is dead wrong with his statement that risks for the Japanese economy are “evenly balanced”. Shirakawa-san, despite his Chicago doctorate and (presumably) Austrian School/Freidmanesque instincts, has clearly not learnt the lessons of the deflation black swans that haunted Dai-Nippon since the 1990’s. Mark my words: the yen can well surge to 78-80, cripple Japan Inc’s export machine, trigger a panic Bank of Japan money printing spree. I can easily envisage the biggest central bank intervention programme in history to restrain the yen’s inexorable rise.

Why else were Chinese sovereign wealth funds buying JGB’s last week? After all, Japan’s entire government debt market is placed onshore, not offshore. What if the world’s central banks and SWF wanted to mimic the Middle Kingdom and boost JGB’s as a reserve diversification instrument?

Why should offshore central bank demand not drive the yen higher, above the April 1995 highs of 79? Yet a yen surge will trigger a Weimar Republic scale (OK, pardon the breathless hyperbole!) money printing spree by the Bank of Japan. I see, borrow Churchill’s words at the Battle of Britain, blood, sweat and tears in the forex bazaar. I see the dollar at both 78 yen and the 100 yen in the next twelve months.

I have been uber-bullish on cable (sterling-dollar) ever since David Cameron and Nick Clegg forged the Tory-Lib Dem coalition that has rolled back the public finance black hole spawned by twelve years of New Labour’s reckless spending binge. History is my friend (but occasionally also a foe) as I trade currencies. I was born in a world where Great Britain was in terminal decline, culminating in an IMF bailout in 1979 and Stalinist trade union politics, until Iron Lady Maggy bet the sceptred isle on capitalism, not the welfare state. Yet sterling punched above its weight in international finance, thanks to the British Empire, North Sea oil, London’s role as the haven of Arab petrodollars, Russian oligarchs and the Eurocurrency markets. Financial markets are all about psychology, not mere capital flows or political fads.

What Sigmund Freud and Carl Jung say about death wishes matters as much as what Mervyn King and Helicopter Ben (now did Bernanke get his nickname? Deflation?) pontificate about interest rates. The psychology of the market tells me now that forex traders fear fiscal Armageddon more than economic soft patches. While Britain faces the most savage public spending cuts since Mrs Thatcher, the US under Obama cannot and will not even begin to address its trillion dollar Uncle Sam budgets.

Sterling’s fall from grace in the twilight of Gordon Brown’s misrule was both brutal and spectacular. Cable plummeted from 2.10 to 1.35, a currency plunge that was more than the ones that followed Ramsay MacDonald’s decision to abandon the gold standard in 1931. Harold Wilson’s (“gnomes of Zurich!”) devaluation in 1968 and John Major’s billion dollar killing gift to Hungarian hedge fund speculator George Soros in 1992. In my misspent youth, I instinctively knew sterling was cheap against the Deutschemark if the Brit Brigade dominated the sizzler beaches of Ibiza, Mykonos and Aya Nappa during summer vacations.

Yet last year, I was in the Greek isles and John Bulls’s offspring (even the tattooed Essex Mon/Bird type) did not grace the islands of the Aegean, Lord Byron’s beacons for the sunlit morning of creation. Ergo, sterling is uber-cheap against the Euro and the dollar!). The UK has the most credible public finance strategy in the Western world. Sure, Chancellor Osborne’s austerity and no rate hike from the Old Lady of Threadneedle Street will cap sterling strength. In any case, my crystal ball suggests 1.68 on cable by Christmas, even if crystal ball gazing forces me to periodically eat crushed glass. Swarovski ,of course, in homage to my Austrian friends!

Views expressed by the author are his own and do not reflect the newspaper’s policy.

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