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Currency market trends into Q2

It has been a rather tumultuous first quarter of 2017 as major global themes have taken root, potentially setting the stage for currency market trends into Q2 and the rest of the year.

Trump

Perhaps most notable of these themes has been a rocky start to the new Trump Administration. From allegations of Trump’s Russian ties to the tentative failure in repealing/replacing Obamacare, President Trump’s performance well within his first 100 days in office has given the markets some pause. However, despite a sharp drop during the latter half of March, equity markets have remained strong and resilient partly on persisting hopes of Trump eventually fulfilling his pro-growth, pro-business economic agenda. Markets have also been supported by a stream of mostly-positive US economic data that has emerged in the past few months.

The Fed

With respect to currencies, the US Federal Reserve has been a key driver of market activity in the first quarter of the year. Despite raising interest rates by a quarter point in March, as widely expected, the FOMC statement provided an outlook for monetary policy going forward that was more dovish than expected. Instead of raising its projections for rate hikes in 2017 as a reaction to expected fiscal stimulus by the Trump Administration, the Fed retained its characteristically dovish tone by reiterating its outlook for only three rate hikes in 2017, inclusive of the March hike. This relative dovishness helped prompt a sharp slide for the dollar and a sharp boost for equities and gold. The dollar’s market reaction has since been pared to a certain extent, as the Fed has once again begun issuing more hawkish signals and key US economic data has continued to exceed expectations.

Brexit

In the UK, the official triggering this past week of Article 50, which formally begins the process of UK/EU separation (Brexit) prompted an exceptionally muted response in UK and other European markets. This was due to the fact that the start of Brexit had already been telegraphed for the past nine months since last June’s UK referendum outcome, and the substantial impact on markets, particularly the British pound, had already been felt and priced-in months ago. The next critical step begins the potentially painful process of trade negotiations between the UK and EU, where a host of complications may present themselves. The renegotiation of trade agreements between the now-separate entities could be a monumental task that may well be rife with considerable pitfalls for the pound. These pitfalls could well be offset, however, by rising inflation pressures in the UK that could help push the Bank of England to begin tightening its neutral policy stance and start raising interest rates, which could give the pound a further lift.

ECB

The European Central Bank (ECB) has also felt pressure from rising inflation. Earlier in March, there were indications that the ECB might be considering an actual rate hike at some point before eventually ending its massive quantitative easing program. This gave the euro a significant boost in mid-March. That boost was rather short-lived, however, as ECB officials gave a message this week that the markets had “overinterpreted” its March communications and that it had meant to stress “reduced tail risk” rather than indicate an impending end to its easy money policy. Combined with this week’s rebound in the dollar, the resulting fall in the euro prompted a sharp breakdown for EUR/USD.

Q2 Influences

Moving into the second quarter of the year, currency market moves will continue to be influenced heavily by the Trump Administration’s progress (or failure to progress) on its economic agenda, the Fed’s policy outlook, Brexit trade negotiations between the UK and EU, and the trajectory of inflation and interest rates on a global scale.

French Elections

On the near horizon, there is also the question of the French elections beginning in late April. If the far-right, anti-EU candidate Marine Le Pen gains more ground, this could place the future of both the EU and the euro in question. The race continues to be close between Le Pen and the independent, pro-EU candidate Emmanuel Macron. In a recent rally, Le Pen proclaimed, “the European Union will die.” Clearly, a Le Pen victory does not bode well for the euro.

US Economic Events

On the more immediate horizon for the US dollar will be next week’s full schedule of economic data and events. Critical US data in the form of both the ISM manufacturing and non-manufacturing PMI reports will be released. Additionally, the always-important US jobs report (non-farm payrolls) will also be released. If the trend of improving US data continues next week, it could make the prospect of four Fed rate hikes even more likely, further providing support for the dollar. Next week also features the minutes from March’s pivotal FOMC meeting. This release will provide further context surrounding the Fed’s decision to raise interest rates but keep its outlook relatively dovish, and could be a significant market-mover for the dollar.

Dollar Strength

Whereas the euro and pound may be facing more risks and pressures going into Q2, the US dollar on a comparative basis appears poised to resume strengthening after its first-quarter setback. With the Fed still standing as the only major central bank in solid tightening mode, and with a clear trend of improving US economic data, the dollar should be fundamentally well-supported for a rise and further recovery against its major counterparts in Q2.

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