Greenback is Flavor of the Month

The USD has surged by 8 percentage points against the euro during the current quarter, and its Bull Run looks set to continue!

Financial analysts and currency traders have been poring over recent data regarding the runaway success of the US dollar. During Q3, 2014 the USD has gained 8% against the euro alone. This has been brought on by a combination of factors, not least of which is the European Central Bank’s decision to implement quantitative easing policies and slash interest rates further. The European Central Bank lowered its prime lending rate to 0.05% and the rate on bank deposits was decreased to -0.2%. The rationale behind these policy moves is to jumpstart the Eurozone economy, prevent deflation and increase the velocity of money flow through Europe.

The short-term effect has been disastrous for the Euro, since it lost considerable ground against a basket of currencies, notably the US dollar. The ECB is targeting an inflation rate of 2%, and that’s in line with the inflation rates in the United Kingdom and the United States. It should be borne in mind that a weaker euro comes with advantages and disadvantages. Imports into Europe will be more expensive, but exports to foreign countries will be cheaper. A weaker euro also supports the hospitality and tourism industry, but it results in increasing prices and inflationary pressures.

EUR losing value against the USD (3 month graph)

Dollar Strength Continues Unabated

The greenback continues to perform above expectations and the US dollar index is evidence of that. The BDSI (Bloomberg Dollar Spot Index) which tracks the USD against a basket of 10 major currencies recorded a 6.7% gain during Q3. According to analysts, this is biggest gain in 6 years. The latest figure for the BDSI was 1,067.28 at 2 PM on 8 October.  It’s interesting to point out that as the dollar increases in value relative to the euro negative gains were recorded on the S&P 500 Index per-share earnings. The combination of decreased oil prices and a stronger dollar has resulted in a strong downward revision in per-share earnings in the S&P 500 index.  Over the course of the next month, 416 companies in the Standard & Poor’s 500 Index will be releasing their financial reports.

US Dollar Index (3 month graph)

Banc De Binary analysts have seen much greater trading activity in the currencies markets over the last quarter than throughout most of the year. The reason being that volatility has returned to the markets. Dollar strength has resulted in falling estimates across the board. And this is expected to continue well into the fourth quarter. This does not necessarily reflect negatively with company earnings estimates. With falling estimates, it is more likely that companies will be able to beat those figures and generate bullish investor sentiment in the process. Some of the stocks that have been performing well of late include those in the financial sector and the healthcare sector. Poor performing stocks include energy companies and consumer staples.

Meanwhile, the Fed will be meeting again on Tuesday, October 28 and Wednesday, October 29 for its next policy meeting. The quantitative easing program (bond purchases) will be ending this month, as the US economy continues to show signs of a recovery. There is a concern among many market participants that economic growth may be slower than anticipated if foreign growth is weaker than they expect it to be. The global slowdown, coupled with strong US dollar performance will not necessarily bring prosperity to America’s shores.

The EUR and the GBP

The USD is presently the strongest performing currency from a basket of currencies. The recently released payrolls report spurred strong gains for the greenback. This period in history marks the most gains for the dollar since the abandonment of the gold standard over 40 years ago. However, buyers are scarce and the greenback will face increasing pressure moving forward.  During the second week of October, the GBP recorded small gains against the dollar but soon retreated after reports of falling inflation in the UK. Currency strategists worry that this will keep interest rates low and make the sterling unattractive to investors. Part of the problem in the United Kingdom is that wages are showing signs of stickiness and they have been rather lacklustre of late. The Bank of England has opted for a laissez-faire approach in allowing the GBP to find its own equilibrium against other currencies.

Prices in stores across the UK dropped at a faster pace, owing to sharp price declines in non-food items. Year on year, retail prices were 1.8% lower in September 2014. In related news, the UK house price growth rate was 9.6 % higher (July, August, September) year on year. This figure tapered off slightly from the 9.7% recorded for in June, July, and August 2014.The pound’s value already takes into account all the positives of the currency and several analysts expect the dollar to continue climbing. In Europe, the anaemic growth rate of Eurozone countries is raising concerns. The UK is expected to be the best performing economy in Europe with a forecast growth rate of 3.2% for the year. This is in sharp contrast to the poor performance of major European countries like Italy, Germany and France.

More bad news came from the International Monetary Fund (IMF) which reported a 40% likelihood that the Eurozone would enter a recessionary period and a 30% possibility that the Eurozone would experience deflation in 2015. The IMF report was far more optimistic about the UK, citing that it had staved off the recession. There are two major reasons why the sterling has suffered against the dollar, including fears of Scottish independence and more importantly the expectation that the Bank of England would raise interest rates. Scotland voted against independence and the BoE has not raised interest rates. What appears to be taking place now is that investors are buying the British pound as it hits troughs in daily trades against the dollar.  Many traders are confident that the GBP/USD currency pair will soon return to levels in the $1.66 range.