rahul.khanna's picture

Major themes in the currency markets

World stock markets have been a risky place since China devalued Renminbi and raised concerns over a weakening global demand. The timing of such a move couldn’t have been worse with three others major themes already playing out simultaneously, we see current volatility to remain.

The timing of US Federal Reserve first rate hike was the number one theme before China threw spanners in the works of the western central bankers. Even though China’s problems have shifted focus from US Fed lift off, the rate hike still remains a key theme going forward. A rate hike in December now seems to be the general consensus, given an improving US job and housing market, even though inflation remains low. If US Fed do not see a contagion gripping the market with its first rate hike, it is likely to go ahead, however, the US rate rise cycle is likely to be shallower and longer than the average in the past. An eventual USD strength is expected but it will be prudent to wait till the current noise in the financial markets quietens.

Another major theme is the European recovery and steps ECB might take to ensure that inflation is set on to the path of recovery despite current challenges like, strengthening Euro and weakening economy in China. Even though European equity earnings are good, and economic sentiments and credit conditions are improving, Draghi in the latest ECB press conference has hinted about expanding the size its current QE program. Given this obsession of propping inflation, we see further downside risks for Euro. 

Oil weakness also remains one of the key themes captivating the markets, but given that the current weakness in oil largely due to supply factors, an overall positive impact should be seen on the global economy. However, weak oil creates troubles for the central bankers by lowering inflation forecasts and this creates further uncertainty in currencies markets.