The British Pound Could Struggle Over Coming Weeks
Currencies around the world saw some of the most dramatic and volatile trading in months on Monday.
Panic set in among investors, as traders reacted to the sharpest fall in Chinese stocks since the financial crisis in 2007.
Stocks in China slumped by just shy of 9% (Figure 1), wiping out what was left of its 2015 gains, as fears of a deep-set slowdown in the country weighed on investors.
Figure 1: Shanghai Composite Index (24/08/2015), Source: Reuters Date: 24/08/2015 Time: 15:45 BST
Traders were left disappointed by a lack of action from the People’s Bank of China, which failed to introduce supportive measures over the weekend.
This action belatedly came on Tuesday, after the central bank slashed rates for the second time in two months to 4.6%
This sharp downturn in Chinese stocks dragged with it share prices around the world. The FTSE 100 extended its run of declines to ten straight days, hitting its lowest level since December 2011 having crashed by over 5% (Figure 2).
European stocks tanked by more than 5%, while the Dow Jones plunged at the open by over a 1000 points to its lowest point since February 2014.
Figure 2: FTSE 100 & DAX Index (21/08/2015 – 24/08/2015), Source: Reuters Date: 24/08/2015 Time: 15:55 BST
The uncertainty caused investors to flee from riskier assets and pile into “safe-haven” currencies.
The Euro soared to its strongest position against the US Dollar in over six months, as so-called “carry trades”, where investors had shorted the Euro to take advantage of the extremely low rates in the Eurozone, were unwound.
The Japanese Yen at one point gained two-and-a-half percent versus the Greenback to its highest level since February.
Unsurprisingly, the Australian Dollar (AUD) and New Zealand Dollar (NZ) fell dramatically, given their economies heavy dependence on demand from China. AUD depreciated by one-and-a-half percent in the early afternoon, while the New Zealand Dollar was down almost four percent at one stage, both tumbling to six year troughs.
The fall in Chinese stocks also drove oil prices lower, down to fresh six-and-a-half year lows. Commodity driven currencies, including the Russian Ruble, South African Rand and Canadian Dollar, have all been under heavy pressure this week.
Amidst all of the drama, the Pound has held up relatively well. Despite suffering from its most volatile days trading against the Euro in six years, Sterling recovered back towards Friday’s close versus the single currency.
Meanwhile, Cable soared to its strongest position since mid-June (Figure 3).
Figure 3: GBP/USD (24/08/15 - 25/08/15), Source: Reuters Date: 25/08/2015 Time: 15:30 BST.
The interest rate cut and reduction of reserve requirements (RRR) by the People’s Bank of China on Tuesday has stabilised the situation somewhat, with stocks worldwide rebounding strongly following their heavy losses.
However, the biggest consequence of what is now being dubbed as “Black Monday”, is likely to be its effect on the central banks in both the US and UK.
Concerns of a China-led global slowdown could delay interest rate hikes by both the Federal Reserve and Bank of England.
Markets are now pricing in less than a 30% chance of a Fed rate hike in September, compared to close to 50% a week ago, with a slowdown in China likely to dent the pace of US inflation that is already nowhere near its 2% target.
Meanwhile, a delayed Fed hike and worsening outlook for global growth will no doubt weigh on policymakers minds in the UK at upcoming MPC meetings.
New York Federal Reserve head Dudley seemed to suggest on Wednesday that the selloff has rattled policymakers enough to bring about second thoughts regarding the need for a September hike.
Delayed interest rate hikes would likely weigh on both the Dollar and Sterling over the short term, with upward trends in the currencies only reasserting themselves once the respective central banks approach tightening measures