Calm on the currency market does not bode well

Central banks on both sides of the Atlantic are delaying a long-awaited interest rate cut for longer and longer. This makes it remarkably quiet on currency markets. But in the past, these types of periods were often the calm before a storm.

This week had all the makings of a nice dose of fireworks on currency markets. In a whole series of countries the central bank makes a decision about the policy interest rate: Japan, Australia, the United Kingdom, Switzerland and Norway. Meanwhile, a lot is happening in the emerging economies. Monetary policy is being scrutinized in China, Indonesia, the Czech Republic, Brazil and Turkey, among others. In reality, traders can be happy if a small (exchange rate) fire goes off. Because it has become very quiet in the currency world in recent months. Maybe even too quiet. Because the last time so little happened was in the period just before the outbreak of the corona crisis.

Less than 1 percent chance
Even the Bank of Japan's (BoJ) decision to raise interest rates for the first time since 2007 did not move the market. It has been expected for a long time that the Japanese policy rate would finally be raised above 0% again. The yen fell by 0,5% after the interest rate decision because the BoJ announced that it would keep a low profile for the time being. The eyes of the currency world are therefore mainly focused on today's Federal Reserve meeting (March 20). In January, the Fedwatch indicator showed that the probability of an interest rate cut was greater than 90%. At the beginning of this week, that chance had dropped to less than 1%.

Who makes the first move?
As long as the American economy is doing well and unemployment remains low (less than 4%), the Federal Reserve prefers to wait before lowering interest rates until inflation is really completely under control. In anticipation of a first interest rate move, attention will be focused on the so-called dot plot in the coming days. This is a graph on which the various central bank board members indicate how the policy interest rate will develop in the future. The currency world is currently anticipating three interest rate cuts in 2024, with the first coming in June at the earliest. If that schedule is pushed back, the dollar may regain some strength. However, the currency has taken a step back compared to the euro since mid-February.

Wild waters
Just like the Federal Reserve, the European Central Bank is also increasingly postponing a first interest rate cut. The value of a euro has been fluctuating between $1,07 and $1,11 for more than four months. If you look at the past, that is a very narrow bandwidth. In recent years, it has been common for the exchange rate to fluctuate by 10% or even more within a few months. It is only a matter of time before the currency markets enter rougher waters again. The surprise will not come from central banks, which pursue a very predictable policy. An unexpected event – ​​such as a sudden turn in the American election campaign or a geopolitical shock – may set prices in motion. There is therefore no harm in covering currency risks now.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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