The U.S. dollar climbed against every major currency this year on the strength of the U.S. economy; a sharp contrast to the struggles of Europe and Japan. The U.S. Federal Reserve transitioned leadership and is on the cusp of changing from an expansionary to a tightening cycle. Ben Bernanke stepped down from the chair of the central bank to make way for Janet Yellen to assume the post. Before he departed, Bernanke announced the Fed’s bond-buying exercise would end in the fall, thereby setting the expectations of a higher interest rate environment next year. American employment has recovered and is now close to pre-credit crisis levels alongside other major indicators.
A strong economy and a central bank poised to raise rates have boosted the USD, but it’s the uncertainty about global growth that secured its place as the top currency in 2014. From political turmoil in the Group of Seven economies like the Scottish referendum, to armed conflict and health crises, 2014 was not short of market volatility. 2015 promises more of the same. That will make for an interesting FX market and one investors can find opportunities to trade in.
The Fed’s Patience is a Virtue
The Fed continues to confound the market as to when it will make its move. Yellen let it slip at her debut press conference at the beginning of the year that rates could be raised six months after the end of the Fed’s bond-buying program. With the Fed’s sprawling quantitative easing (QE) initiative ending last fall, the tightening cycle could begin as early as the spring of 2015. However, some Fed members have issued statements that the central bank needs to be patient and raise rates only when necessary, while others are urging for the start of the rate-hike cycle. That tone and perspective made its way into the official Federal Open Market Committee (FOMC) as was evidenced by the FOMC’s final statement in 2014.
The EUR/USD price action has been driven by the European Central Bank’s (ECB) desire to launch an effective stimulus program to reverse European deflation, and the strong U.S. economic data driving the Fed toward a rate hike sometime next year. The gridlock between Germany and Southern Europe around the purchase of sovereign bonds as part of a QE program has rendered all alternatives fruitless. The market expectations are for the stimulus crowd to win out, but things in Europe might have to get worse as the anti-austerity movements gain traction. Lower European rates and a boost from the ECB will keep the single currency depreciating against the dollar, so long as the Fed stays on course in the opposite direction. The resulting rate divergence will keep the USD bid against all major pairs and emerging markets.
U.S. Growth Moderate but Outpacing Developed Economies
Federal Reserve Bank of New York President William Dudley said market expectations about a higher benchmark interest rate are well founded. The former Goldman Sachs economist sees U.S. growth as stable and conditions such as low oil prices being beneficial, as it reduced the price of energy imports. The U.S. economy grew by 4.6% in the second quarter one year after a harsh winter laid results in the first quarter low. The surprise came in the third quarter where growth beat expectations to make clear that it was not a single quarter bounce as gross domestic product data increased by 3.9%. Dudley sees slower growth in 2015, but still around 2.5% to 3%, with a rate hike likely midyear 2015.
The International Monetary Fund, the World Bank, and the Organization for Economic Cooperation and Development have all cut their global growth forecasts for 2014 and 2015. Here divergence among recovering economies is clear as the U.S. and the U.K. lead the developed world with Europe and Japan at a standstill.
Emerging markets continue to struggle trapped between diminishing foreign direct investment that is diverted to safe-haven assets as major central banks keep the markets on edge, and unfolding geopolitical events diminish appetites for riskier investments. The U.S. has benefited from safe-haven inflows. The American economy remains solid as commodities continue to plummet, and investors struggle to diversify their portfolios as they search for stability.
USD on an Uncertain Fast Track
Japan and Europe depend on the Fed to stick to its intended plan in order for their stimulus to have an impact and boost growth. The Fed tightening, and the BoJ’s and ECB’s expansionary policies, should result in further USD dominance next year. Central bankers have heavily dictated the pace of the post crisis economy acting in concert. Uncertainty will build up with the Fed breaks the ranks to be joined by the Bank of England once the U.K. elections have passed. Higher rates in the developed world are coming and the dollar is set to take advantage. Central bankers in Europe and Japan will have their work cut out for them as Yellen and the rest of the Fed have an easier job of keeping the economy on track.
One of the drivers of the U.S. recovery has been a weak dollar as it allowed America to recover its exporting edge while reducing imports. With that competitive advantage gone continued growth will come with agreements like the Trans-Pacific Partnership (TPP) where Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States and Vietnam aim to create a trade pact to boost growth among members and defy the lower growth forecasts for next year. Challenges abound for the TPP to move forward, ironically Japan and the United States are two of the last members to join, and they continue to block the agreement from being ratified to negotiate tariff reductions protecting national lobbies.
2014 proved to be an eventful year for the global forex market. Shock central bank decisions, political turmoil in Europe, and the projected slowdown in China that is about to become a reality has seen the resurgence of the USD as the go-to currency. Gold has decoupled from global conflict as a safe haven, and in a world with little inflation, it has seen its usefulness decline. Increased volatility also means that current trends can be reversed when taking into account a patient Fed and a near-desperate ECB facing off against a stern German blockade.