March FX Roundup

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As with February, much of the volatility across the foreign exchange market during March has been driven by developments in Ukraine and their subsequent effect on markets and market sentiment. Monetary policy announcements, including the Federal Reserve and Bank of England’s decision on the 16th and 17th March to raise interest rates by 25bp respectively, also saw considerable market movement as did inflation figures surpassing levels not seen for forty-years across major economies and evidence of global growth slowing. Other major economic events this month included the Chancellor’s Spring Statement delivered on 23rd March, further sanctions on Russia being applied from much of the global community and further volatility across the energy markets culminating in crude oil hitting 14-year highs at $126 per barrel on 7th March.

While there has been some improvement to the prevailing risk off sentiment given the resumption of dialogue between Moscow and Kyiv at the back end of this month, safe haven currencies including the Swiss franc and US dollar have performed strongly given the precarious geo-political climate. For example, the DXY Index which measures the value of the United States dollar relative to a basket of six other foreign currencies rose from lows of around 96.6 on 1st March to highs of 99.3 on 7th March before losing territory and slipping below 98 as diplomatic talks in Turkey on 29th March improved the prospect of negotiations yielding a diplomatic outcome. Likewise, the Swiss franc performed strongly during the first week of March even rising above parity against the euro for a few hours on the morning of 7th March. However, as the extent of the prevailing risk off sentiment decreased somewhat, the euro regained some of its lost ground testing the 1.0400 level of resistance against the Swiss franc.

One safe haven currency that performed poorly over March was the Japanese yen which deprecated from 114.6600 against the dollar at the start of the month to 124.500 by 28th March - its lowest level in seven years. This included a 2% drop on 28th March when the Bank of Japan indicated that they would continue to pursue a course of loose monetary policy, diverging away from most other central banks. For example, the BoJ offered to purchase an unlimited number of 10-year Japanese government bonds in an effort to keep these bond yields low. It is also worth highlighting that the BoJ has kept interest rates at -0.1% since 2016 and has a considerably lower level of inflation at 0.9% than much of the world. Hence, as other economies raise rates faster than expected to help combat inflation, the interest rate differential between the BoJ and other central banks has continually grown.

On the subject of rates, as stated on 16th March the Fed raised rates by 25bp bringing the base interest rate to 0.5% with a further three hikes of 0.25% by the end of the year priced into the market. The US central bank continue to find themselves in a precarious balancing act, exacerbated by the recent developments over the conflict in Ukraine as the rising cost of energy and food helped push CPI figures to their highest level in 41 years at 7.9% (with most forecasts expecting this level to continue to climb, perhaps into double digits). While this figure remains around four times higher than the Fed’s target rate of 2% - the Fed’s appetite to raise rates are severely hindered by the desire not to dampen growth, as worries over a looming recession continue to grow.

Such concerns were aggravated on Tuesday 29th when the US yield curve briefly inverted, meaning that for the first time since 2019, two-year treasury yields (which rose as high as 2.45%) were above that of the ten-year yields (which fell to 2.38%). Given that this signal has been a prelude to every recession in the US since 1950 (within the space of two years), many investors are considering it as a red flag moving forward, especially given that inflation reaching levels not seen for four decades is forcing the Fed to raise rates quicker and for longer than previously anticipated. Nevertheless, as analysts including Erin Browne of Pacific Investment Management Co. have pointed out “[the] yield curve inversion may not be as good of an indicator as it has been in the past, particularly given the enormous amount of quantitative easing undertaken by global central banks”. That said, following the conflict in Ukraine and soaring energy prices, growth forecasts in the US have been revised down by almost all of the major financial institutions including Goldman Sachs, Bank of America and the IMF. For example, the Goldman Sachs forecasted 1.75% growth in 2022 down from their previous predictions of 2%. Furthermore, citing the yield curve, they also put the chances of a recession in the US next year between 20-30%. Goldman’s predictions are however considerably less optimistic than the Fed who predict 2.8% growth this year, although when considering that the OECD’s December forecast predicted 3.7% growth over 2022, the impact that the war in Ukraine has had on growth projections is increasingly apparent.

The downward revision in US growth forecasts is illustrative of the outlook for the global economy more generally. For example, this month Fitch cut their global GDP predictions by 0.7 percentage points to 3.5% given the impact that Russian sanctions could have on global energy supplies. Such sentiments were also shared by the UN who cut global growth forecasts to 2.6% from 3.6%. In Europe, Fitch also raised the possibility of ‘outright shortages and energy rationing’ as they slashed their expectations of growth in the Eurozone by 1.5 percentage points to 3.0%. Such fears became increasingly salient on 30th March as a spat between Berlin and Moscow resulted in Putin threatening to turn off the taps after Germany refused to pay existing energy contracts in the Russian ruble. Given Germany’s apparent reliance on Russian gas and Putin’s reliance on gas revenues it is evident that this display of brinkmanship will likely continue as tensions escalate.

In conclusion, March has been a month of great volatility in the world of foreign exchange and looking ahead this trend is expected to carry through into April where all eyes will be focused on the conflict in Ukraine, inflation prints and any shift in central banks’ sentiment vis-à-vis monetary policy.

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