While the Fed ended its third round quantitative easing in the US, Japan shocked everyone by expanding its QE to an unprecedented level and the Eurozone is on the verge of commencing QE to prevent deflation. But what are impacts that these events are having on the financial markets and key currencies? Gita Evele, PR manager at online broker Exante, spoke to Giovanni Pozzi, Partner and head of FX at JCI Capital, to comment on the matter.
The Eurozone is facing various issues – stubbornly high unemployment at 11.5%, sluggish GDP growth of 0.1% in Q2 and inflation at 0.4% reaching the deflation territory. While the Fed had to implement three rounds of QE in the US, many argue that it is now time for QE in the Euro area. Do you believe it is the solution and why do you believe Draghi has been refraining to implement it so far?
Eurozone issues are very serious and can be summarized as a big competitiveness issue. Competitiveness in this case means internally for Europe to survive with lower margins, and externally in terms of being able to export well despite competitors from EM as well as the rest of the developed world. If Europe is not careful enough not to lose too much competitiveness, then these issues will have a serious impact socially. The key way to smoothen this impact is a strong ECB quantitative easing support; it is taking long because of the political and substantial opposition from Germany. Another reason is that Europe wants to make sure to take into account both good and bad consequences from the experience of US QE. Europe is trying to make something more sophisticated than we witnessed in the US, not just pumping liquidity, but pumping liquidity and understanding where this will end up as well as ensuring the effectiveness of the transmission mechanism. And it is not easy for a region which is not really unified in terms of anything except for the Central Bank.
Nonetheless, QE will have to come, and the time is not far. Otherwise, the Euro is still at risk of falling apart due to the fact that the political and social tensions in the single countries will become too strong.
At the same time, countries like Italy will have to work hard on reforms, while taking advantage of ECB’s help to fight deflation as well as a deep and extended recession. The Euro depreciation will be key for competitiveness and reflation, and a clear consequence of ECB’s QE measures.
Mr. Kuroda, BOJ Governor, shocked the markets by expanding its QE to an unprecedented level – increased its bond purchases to around ¥80 trillion ($712 billion) each year and extend the average duration from 7 years to 10 years. By promising to do whatever it takes to hit the 2% inflation target, the JPY dropped to a 7-year low against the USD on Wednesday, 5 November. Do you see this as a deliberate move to push the JPY lower in order to spur the economy?
Japan has embarked on a clear path towards reflation which among other things includes Yen weakness. Thus, the Yen weakness is one of the pieces of the puzzle. Japan’s acceleration on QE may speed things up for the ECB as Japan is certainly a direct competitor for Germany.
Some economists say that the US economy remains fragile despite signs of a slow recovery. What are the likely risks for the USD now that the Fed ended its QE programme last week?
I remain very positive with regards to the US Dollar, because I think the path of divergence between their phase of the QE and European as well as Japanese phase of QE is a fact, and the US dollar will appreciate on the back of that.
However, that does not mean that the US market cannot retrace in terms of equity value and bond value, and there is a clear risk especially for the bonds deriving from how the Fed will manage the rate hikes when they come. So far they have done a spectacular job of explaining to the market with their forward guidance that they do not intend to have a market shock on the bonds, and I believe they will be successful. Therefore, to my mind, there will not be any shocks on US bonds, however, there will be a correction with not too much volatility.
As concerns the equity market, the situation is more complicated. I believe that the analysis should depend on the data that comes out both for the corporate data (the year ahead, quarterly data etc.) and for the macroeconomic data (i.e. payrolls etc.). Hence, the equity market will move in time with that.
Apart from the already discussed, what in your view will be the key drivers for EUR/USD and USD/JPY until the end of the year and Q1 of 2015?
I believe the key factor for both currency pairs is the real money flows: Central Banks and SWF’s money have reasons to move back to USD, how much and how fast will dictate the rhythm of the move.
What are your forecasts for EUR/USD and USD/JPY until the end of the year and Q1 of 2015?
As concerns the EUR/USD, I see it dropping to 1.18 by the end of the year and to 1.15 in the first quarter of 2015. With regards to the USD/JPY, our forecast is 116.50 at the end of 2014 and 119 in Q1 of the following year.
Mr. Pozzi has been active in the FX markets since the early 90’s. He has held senior positions as market maker and proprietary trader at American Express Bank, SBC Warburg and UBS. Prior to his work at JCI Capital, Mr. Pozzi was CEO at JW Partners, a research and advisory firm focusing exclusively on FX.