One of the most striking developments is the end of the carry trade – a strategy that consists in borrowing in a low-interest-rate currency and investing the money in a high-interest-rate currency. For such a strategy to work, however, two conditions are indispensable: wide divergence between interest rates and low volatility. This is no longer possible. The interest-rate differential between the principal economies has narrowed sharply and the more uncertain economic and political backdrop has rekindled volatility. We expect it to increase further in the months ahead as the US presidential election approaches. This is usually a fairly favourable market environment for the US dollar.
After two years of economic stagnation and a good first quarter of 2024, the eurozone is sliding once again into stagnation. The ECB’s rate cut will not change this. What’s more, foreign capital inflows in search of undervalued companies in the European market, which for a time boosted the euro, are now leaving the continent. Where are they headed? Into the US, where the economy continues to outperform. This is structurally bearish for the EUR/USD.
Amid the resurgence of political risk on the European Continent, it will surely be difficult for the EUR/GBP to break above 0.8490-0.8500 in the short term.
The US dollar continues to benefit from a positive trend against almost all G10 currencies, including the GBP. The cooling of core inflation in the US is a positive signal. If this continues over the next two months, US monetary loosening may kick off in September. In this perspective, we forecast a single 25 basis point rate cut this year, followed by just three rate cuts in 2025. US monetary policy is set to restrictive for some time, supporting the dollar. In combination with the steepening of the UK Gilt curve, this creates the perfect cocktail for bringing the GBP/USD cross back below 1.25.
The internationalisation of the Chinese currency continues. It had come to a sudden halt following the triple devaluation in August 2015. According to Chinese customs data published at the end of June, the share of merchandise and services paid for in CNH by the country is 30% above its 2015 peak. On the foreign-exchange front, it seems clear that the Chinese authorities favour stability. This is likely to be reiterated at the Third Plenum due to begin on 15 July that will set the country’s principal economic objectives.
There is not much to report on this pair during the month. The trend clearly remains upwards. For the time being, the Swiss National Bank has halted its direct interventions in the money market, apart from very occasional interventions for accounting purposes.
Oops! A bad surprise on the inflation front in Canada. No-one was expecting this. The May consumer price index reaccelerated to an annualised 2.9% versus 2.6% forecast. This is very bad news and the Bank of Canada may reflect twice before cutting rates again. It is also fairly negative for the Canadian dollar, in our view. In any case, it could not be a worse reminder that the battle against inflation is not over everywhere.
Canada is not the only country in a bad way on the inflation front. Australia has also faced a nasty surprise, to the extent that the Reserve Bank of Australia may raise its policy rate in August. If confirmed, this would be somewhat positive for the Australian dollar. In the long term, however, we are still bullish on the EUR/AUD pair.
Will it or won’t it? Over the past fortnight, Japan has gone on the offensive. It is unhappy about the weak yen. New money-market interventions are possible, like the one at the start of May. Unfortunately for Japan, it is unlikely to achieve a lasting appreciation of its currency. That said, it may manage to stabilise the yen within a range we estimate at between 167 and 170 for the EUR/JPY, as was the case in the wake of the financial crisis. Today, the pair is above 173.
As expected, the Hungarian central bank scaled back the pace of rate cuts to 25 basis points at its June meeting. Forward guidance was an important factor in explaining the appreciation of the Hungarian currency. The central bank signalled that it may opt for a monetary policy pause, despite obvious improvements on inflation. We think the monetary status quo may continue for the rest of the year. Be aware that the HUF has limited upside potential, in our view, because of the weakened international environment, marked by higher geopolitical risk, oil price strains (the WTI is up 10 dollars in one months) and the outlook for a US presidential election on 5 November that will spur a retreat to the least risky currencies.
For the past several weeks we have seen a rise in volatility linked to the macroeconomy and political and geopolitical risks. Unsurprisingly, this is a favourable cocktail for the US dollar, which will serve as a safe haven for investors to protect themselves against what might happen in the second half of the year – the US presidential election, for example. In these conditions, it will surely be difficult for the HUF to outperform the USD in the months ahead, despite the ongoing macroeconomic improvement in Hungary, especially in the job market.
| DATE | CURRENCY | EVENT |
| 15/07 | CNH |
Third Plenum of the Chinese Communist Party |
| 17/07 | EUR | Eurozone inflation figures |
| 18/07 | EUR | European Central Bank meeting |
| 24/07 | CAD |
Bank of Canada meeting |
| 31/07 | JPY |
Bank of Japan meeting |
| 31/07 | USD |
US Federal Reserve meeting |