This comes amid worries about domestic currencies’ positions compared to a strong dollar in the face of tariffs. 

In China, foreign reserves rose by $40 billion in January thanks to increasing private and corporate foreign reserves purchases – likely connected to fears of a yuan depreciation. This was the biggest rise since April 2021, bolstered by both individuals and non-financial institutions.

In Indonesia and India, central banks are shoring up domestic currencies by shorting the dollar through derivatives, pointing to worries about the knock-on effects of tariffs against China on the region.  

The Asian economic giants have been on edge ever since the first round of US tariffs was announced, fearing a drop in exports could harm domestic economies and devalue currencies. The US is the biggest single importer of Chinese goods; Trump’s wide-ranging tariff regime, including a 10% tariff on all goods and specific measures targeting shipments from low-cost Chinese retail giants, could significantly impact the foreign exchange rate in the next months. 

The Chinese economy has been faltering in the last year, with frequent rate cuts by the Chinese central bank struggling to revive it. Amid low interest rates and fears of a recession, exacerbated by the potential effects of US tariffs, Chinese investors will be looking towards foreign currencies—especially the dollar—for higher yields and more security. 

Elsewhere in Asia, central banks are using derivatives, like net dollar short forward positions, to protect their own currencies against a strengthening dollar. The Reserve Bank of India has recently increased its net dollar short forward position to an all time high, while the Indonesian central bank’s net short book reached a 10-year high this month. 

Some see this as an attempt to temporarily strengthen currencies by making commitments that may be hard to keep in the future. However, it could also signal confidence from Asian banks that the current tensions between Asian giants and the US are only temporary and will not have a wide-ranging effect on the region. 

Already, the limited nature of the tariffs that have been announced – a far cry from the 60% discussed during Trump’s campaign – could reassure investors. Growth in the Chinese tech sector, driven by the launch of the Chinese AI app DeepSeek, a low-cost alternative to ChatGPT, could also boost the economy. 

These currency trends could have a knock-on effect on the type and magnitude of tariffs the Trump administration sets on Asian exporters. Trump has accused China of currency manipulation as far back as 2018, and US Treasury Secretary Scott Bessent has recently announced an investigation into currency manipulation as a way to lower the impact of tariffs, expected to produce results by 1 April.  

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The design note outlined four key workstreams that will shape the future of Britain’s digital currency: product vision, scheme regulation, technology architecture, and operational framework.

The initiative envisions a public-private partnership model in which the Bank would build and operate the core infrastructure; regulated private firms would manage customer-facing services as payment interface providers (PIPs) and external service interface providers (ESIPs), accessing the core infrastructure via application programming interfaces (APIs)

This model is designed to encourage innovation whilst maintaining the Bank’s traditional role as guardian of monetary stability and encouraging commercial viability to the public.

The proposed framework would allow seamless exchange between the digital currency, traditional cash, and bank deposits.

The design phase includes extensive stakeholder consultation, with the Bank actively seeking feedback from financial institutions, technology firms, and civil society groups. 

However, no final decision has been made on whether to proceed with implementation. Should the project advance, it would require parliamentary approval through primary legislation. The Bank estimates full implementation would take several years, with features being rolled out incrementally.

Central banks around the world are trialling digital currencies: the European Central Bank is progressing with its digital euro project, and China has already launched pilots for its digital yuan.

Source: Bank of England

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• 2024 ICC Trade Register report reaffirms low risk nature of trade finance assets, despite a slowdown of global trade volumes in 2023.
• Receivables finance is outpacing traditional documentary trade products, marking a shift towards open account trade and flexible working capital solutions.
• The report highlights a notable shift towards trade in regional blocs, particularly growth in non-USD settlements.

The annual Trade Register from the International Chamber of Commerce (ICC) in collaboration with Boston Consulting Group (BCG) and Global Credit Data (GCD) has been released, analysing the landscape for trade, supply chain finance, credit risk, and proprietary trade finance risks for 2023. 

The report surveys partner banks of the ICC Banking Commission, representing 5% of global trade flows and 18% of financed trade flows. The conclusions are indicative of the industry’s trajectory and highlight opportunities down the road.

2023 was mired by ongoing geopolitical tension, stilted market demand, corporate deleveraging, and high interest rates, transforming the industry. Overall, though, indicators for 2024 are positive, while the low-risk nature of trade finance remains a pillar of stability.

Trade: 2023, 2024 forecast, beyond

Global goods trade saw a year-on-year decrease in both real terms (-0.7%) and nominal terms (-4.8%): a slowdown from growth post-pandemic in 2021 and 2022.

The variance of this by sector is interesting in defining the future of commodity demand. The energy sector fell by 19% in nominal terms (while demand remained steady, increasing by 1% in real terms). Modest downturns were seen in metals and mining (-7% and -9%), semifinished intermediate good such as chemicals (-10%), semiconductors (-10%), and agribusiness (-4%).

On the other hand, automotive trade increased by 12% in nominal terms while the aerospace sector saw a 16% increase. 

This was offset by an 8% increase in services trade, now making up one-third of all trade. In nominal terms, this constituted $7.9 trillion, with Middle-Eastern countries (Saudi Arabia, UAE, Qatar), India, and Ireland witnessing the fastest growth.

Sectorally within services, the travel industry rebounded strongly, returning to approximately 25% of the global services trade. Financial services and information and communications technology (ICT) also saw steady annual growth. Conversely, construction services reported slower growth.

Global inflation fell from 8.0% in 2022 to 6.5% in 2023. But despite the moderation of inflation, consumers continued to suffer expensive essentials like energy bills.

In terms of trade currency, while the US dollar is likely to retain its dominance in the short term, non-US dollar trade is on the rise. This is driven by increased use of Chinese currency in cross-border payments; and by US foreign policy affecting specific sectors, with around 20% of the global oil trade settled in non-USD currencies.

Having said this, the USD’s dominance is still decisive, with 55% of international payments and 83% of trade finance market payments made in the American currency.

Looking forward, as central banks have reduced interest rates in response to waning inflation, 2024 should theoretically be reviewed as a year of relative normalisation. Yet the year has been defined by shifting geopolitics, the result of elections for more than half the world’s population and conflict.

Supply chains have seen monumental rerouting. The drop in trade between the US and China has pushed both parties closer to their allies. Similarly, the EU has been seeking to diversify from Russia and China.

But surprisingly, the strongest growth has come from the ‘Global South’, which largely consists of emerging economies. India’s trade growth is expected only to accelerate, at 9% CAGR over the next decade. The benefits of campaigns like ‘Make in India’, as well as continued growth in projected trade with China, reinforce India as a rapidly emerging platform.

Trade and supply chain finance

Slowing trade volumes, compounded by higher interest rates, posed challenges for trade and supply chain finance. Banks reported the following as the greatest threats to their businesses:

• Disrupted trade flows from ongoing geopolitical conflict (40% responded this to be a high or severe threat)
• Margin erosion (36%)0
• New regulation on capital treatment (30%)
• Increased competition amongst financial institutions (25%)
• Increased fraud risk (21%)

Trade and SCF revenues declined overall, with the most notable contraction in the Asia-Pacific region. But the only modest reduction in the EU, which accounts for one-fifth of global trade finance revenues, lessened the severity of this decline.

While some expect receivables finance and payables finance to accelerate faster than the growth of documentary trade and trade loans, the proportions within overall trade and SCF revenue growth remain steady. 

In fact, documentary trade products are projected to have a below-average growth at 3.7% CAGR, and reduced demand for payables finance comes as a result of disclosure rules and Basel III capital treatment regulation.

Nonetheless, the wider picture is positive for trade finance. Much optimism comes from the modernisation of platforms, the result of the rapid evolution of technological solutions. As many as 90% of banks are investing in digital customer experience initiatives to meet client expectations.

Artificial intelligence (AI) and generative-AI have huge potential regarding data extraction, fraud prevention, document checking, and creating data model language universality. This technology can also improve accessibility for smaller, less technologically-literate parties by providing validation and assistance in contracts, and by using chatbots to simplify customer service.

In this regard, momentum picking up around digital trade and related regulation, such as the Model Law on Electronic Transferable Records (MLETR), is likely to have informed positive projections. However, 80% of survey respondents believe the digitalisation of trade is dependent on collaboration throughout the ecosystem – corporates, shipping companies, banks, insurance brokers, as well as regulatory bodies. 

Climate and sustainability remain important, with a notable change from banks. Over 90% of those already engaging in sustainable finance report positive growth. In Western Europe, regulations like the EU’s Carbon Border Adjustment Mechanism mandate this transition, but creating profit incentives around sustainability mean its significance will only grow.

Credit risk, proprietary trade finance risk

The report proposes that trade finance, SCF, and export finance have proven resilient from a credit risk perspective because they involve low-risk transactions, which constitute the bulk of global trade. 

These instruments represent a low-risk asset class, even during times of uncertainty: as elucidated by Figure 4. On an exposure-weighted basis:

• Global default rates for import letters of credit (LoCs) decreased from 2022 to 2023.
• Default rates for export LoCs are significantly lower than for other trade finance products, and defaults increased negligibly between 2022 and 2023.
• For loans for import/export, 2022 to 2023 saw a slight decrease.
• Default rates for performance guarantees decreased in 2023 (this was on an obligor-weighted basis too).

For export finance, most transactions are guaranteed by export credit agencies at up to 100% of their value. In the sample surveyed, the average was 94%. This grants banks the capacity to be indemnified by an export credit agency (ECA) up to the level specified, meaning export finance has a particularly low loss given default (LGD) levels.

—

The findings of the 2024 ICC Trade Register Report are consistent with commentary throughout the year, regarding the significant disruptions posed by geopolitical uncertainty as well as the opportunity provided by technology. It is in this opportunity that positive forecasts seem to stem.

Importantly, however, the findings in this year’s report align with previous reports: that trade finance, SCF, and export finance present a low risk for banks. These trade finance instruments appear, in their nature, to be insulated from inevitable disruptions.

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Fitch Ratings has upgraded Turkey’s Long-Term Foreign Currency Issuer Default Rating (IDR) to ‘BB-‘ from ‘B+’, citing improved external buffers and reduced contingent foreign exchange (FX) liabilities. The outlook is stable.

The upgrade reflects a strengthened external position. Turkey’s FX reserves have risen to $149 billion, with net reserves at $41 billion. This improvement stems from reduced reliance on foreign currency in domestic transactions, lower FX demand, increased foreign investment, and enhanced ability to secure international loans.

The central bank’s net foreign asset position has also turned positive for the first time since early 2024.

These improvements will likely be more durable thanks to positive real interest rates, low current account deficits, and the regular decline in FX-protected deposits. FX-protected deposits have fallen by two-thirds to $46 billion from their peak in August 2023.

Another factor is an expected consistent policy mix. Turkey’s central bank has hiked its policy rate to 50% and implemented measures to strengthen policy transmission, leading to the lira’s real appreciation.

Fitch has projected a gradual narrowing of the central government deficit from 5% of GDP in 2024 to 2.8% by 2026. This improvement, the agency says, will be underpinned by a tapering of earthquake reconstruction spending, tighter fiscal discipline, and enhanced tax collection efforts.

The ratings agency forecasts a decline in Turkey’s general government debt to 27.3% of GDP, well below the ‘BB’ median, buoyed by robust nominal GDP growth and lira appreciation.

Despite the IDR upgrade highlighted ongoing risks, including the potential for policy reversals given Turkey’s recent history of unconventional economic policies. Fitch projects economic growth to slow to an average of 3.5% for 2024 and 2.8% in 2025 as tight monetary policy and fiscal consolidation cool domestic demand.

The agency also noted that Turkish governance indicators have deteriorated over the past decade and remain weak relative to peers.

For instance, inflation is expected to decline to 43% by the end of 2024 and 21% by the end of 2025. But given that projected inflation is still high—the highest in the BB category—any inflationary triggers could jeopardise Turkey’s balance of payments and associated risks.

Additionally, Turkey’s environment, social, and governance (ESG) profile presents significant challenges, according to Fitch’s assessment. The country scores poorly on both Political Stability and Rights, as well as Rule of Law and Corruption Control, reflecting weaknesses in institutional capacity and the application of law that harm its credit profile.

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Revolut Business customers now only require a card number for transactions, and payments arrive in the recipient’s account within 30 minutes. 

The collaboration aims to streamline international transfers for businesses, addressing traditional challenges of expensive transfer fees, lengthy processing times, and complex information requirements (for example, International Bank Account Numbers and Business Identification Codes, or IBANs and BICs).

The partnership is powered by Visa Direct, a network which enables real-time payments. It is available in over 78 countries and supports over 50 currencies.

Instant Card Transfers are expected to benefit various business scenarios, from startups paying contractors to travel firms managing customer compensation.

This global agreement builds on previous collaborations between Revolut and Visa. In 2023, the two teamed to offer card transfers for peer-to-peer payments to 90 countries; and to launch Visa virtual cards for businesses in the B2B travel sector earlier this year.

James Gibson, General Manager at Revolut Business, said, “We’re excited to launch Instant Card Transfers in the UK & EEA, providing businesses with a simple, instant, and secure way to pay employees, contractors, and customers globally by supporting major card schemes.”

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South Korea is set to permit offshore companies to apply for trading rights in its local currency market starting next month. This move is part of the country’s ongoing efforts to have won securities included in major global indexes. 

The decision received approval from President Yoon Suk Yeol’s cabinet earlier this week and will come into effect on 18 October, as confirmed by statements from the Finance Ministry.

In a broader context, South Korea has been reassessing its domestic trading restrictions with the aim of easing them. The goal is to make won-denominated assets a part of developed-market indexes, thereby attracting more foreign investment into the local economy.

Registered foreign institutions will be granted the ability to trade in the domestic market via FX brokerage firms. These institutions will also be required to demonstrate their financial stability and establish sufficient credit extension agreements with current market participants, among other prerequisites, according to the ministry.

Currently, the won is traded through local banks in Seoul between the hours of 9 a.m. and 3:30 p.m. The authorities have long-term plans to keep the onshore won market open 24 hours a day, with an initial extension to 2 a.m. planned for next year.

As of Tuesday, the won has depreciated by 0.9% against the dollar, hovering around the 1,348 level. The currency has seen a decline of approximately 6% this year.

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Late Tuesday afternoon, Fitch downgraded the United States’ credit rating from AAA to AA+, to the surprise of many experts.

This downgrading is the latest domino to fall in what has been a drama filled 2023 for the United States and its divided government.

The United States government was bogged down in a debt ceiling battle earlier this year in May, which sparked initial concern for potential credit downgrading.

During this debt ceiling face-off, Fitch placed the United States’ AAA rating on watch, stating that further insecurity could lead to a downgrade.

However, the government reached a deal in the 11th hour, avoiding a debt default, and calming the nerves of credit rating agencies across the world.

Or so they thought.

For Fitch, this temporary debt ceiling deal clearly did not move the needle very far, as this was just one factor in their decision.

The rating agency released a statement saying, “In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025.”

Initial reaction

A sense of surprise could be felt from experts and pundits alike across the United States on Tuesday.

Former United States Treasury Secretary, Larry Summers took to social media platform X to criticise the decision.

Current Treasury Secretary Janet Yellen said that Fitch’s decision was “arbitrary” and said “Treasury securities remain the world’s preeminent safe and liquid asset, and… the American economy is fundamentally strong.”

Chief economic adviser at Allianz, Mohamed El-Erian added to the criticism.

Alec Phillips, chief US political economist at Wall Street bank Goldman Sachs said, “The downgrade mainly reflects governance and medium-term fiscal challenges, but does not reflect new fiscal information.”

Economist Paul Krugman said the timing of this downgrading was “bizarre”, especially given the recent inflation report and the continued strength of the American economy. 

A recent report noted that United States inflation grew at its slowest pace in over two years, reaching 3% in June. While 3% is still above the Fed’s target goal of 2%, it marks significant progress from the 9% inflation seen in June 2022.

The positive inflation report was followed by a study showing that the United States economy grew 2.4% between April and June, which was significantly above the expected 1.8%.  

A precarious American environment

But not everyone is sold on the underlying fundamentals of the United States economy. 
According to the St. Louis Fed, as of Q1 2023, the United States’ debt is $31.5 trillion, and the interest payments on this debt are nearing $930 billion.

Federal government current expenditures: Interest payments

Along with the rising debt and interest payments, the United States is not out of the shadows of the debt ceiling. In the 3 June debt ceiling deal, the government simply kicked the can down the road. The government faces another looming fight, as they will need to negotiate another deal in January 2025.

The timing isn’t great either.

January 2025 will likely be filled with other political tensions. President Joe Biden will either be preparing to be sworn in for his second term on the heels of a highly contentious election, or there will be a lame-duck administration, as one of his many Republican contenders, led by former President Donald Trump, will be inaugurated at the end of the month.

Fitch’s reasoning

Fitch laid out some of their driving points for their credit rating decision. 

• Erosion of Governance: The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management. In addition, the government lacks a medium-term fiscal framework, unlike most peers, and has a complex budgeting process. These factors, along with several economic shocks as well as tax cuts and new spending initiatives, have contributed to successive debt increases over the last decade.
• Rising General Government Deficits: We expect the general government (GG) deficit to rise to 6.3% of GDP in 2023, from 3.7% in 2022, reflecting cyclically weaker federal revenues, new spending initiatives and a higher interest burden.
• Medium-term Fiscal Challenges Unaddressed: Over the next decade, higher interest rates and the rising debt stock will increase the interest service burden, while an ageing population and rising healthcare costs will raise spending on the elderly absent fiscal policy reforms.

Ultimately, there is some disagreement about the timing of the rating downgrade. While there have been a slew of positive reports for the United States economy, as mentioned earlier, Fitch still decided there were a number of underlying factors that led to a loss of confidence. 

As many experts mentioned, there will likely be a limited or subdued market reaction to this decision, as the rating of AA+ still falls well within the Investment Grade and iForex ratings, and the United States Treasury Bills are still viewed as one of the safest investments in the world.

But this decision is yet another data point signalling growing discontent and concern over the political system in the United States.

Regardless of strong economic numbers, instability and infighting will continue to hamper the outlook of the American political and economic system.

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The Indian rupee depreciated on Monday and appeared set to register a monthly decline due to a central bank that seems reluctant to allow the currency to strengthen significantly.

As of 11:02 IST, the rupee stood at 82.2625 against the dollar, a decrease from 82.2475 on Friday. Throughout July, the local currency has fallen by 0.3%.

During the current month, the rupee experienced a pair of instances when it reached the 81.70-81.75 range, after which it had to face intervention from the Reserve Bank of India (RBI). 

According to traders, the central bank purchased dollars around that level through public sector banks to prevent the rupee from appreciating further.

Despite foreign equity inflows exceeding $5.5 billion and a weaker dollar index, the RBI’s determination offset these factors.

As the RBI appears steadfast in their stance, the rupee is anticipated to remain within the 81.70-82.50 range for the time being.

In July, the dollar index fell by 1% amid expectations that the US Federal Reserve’s rate cycle has concluded. Investors reacted to softer US inflation data by speculating that the rate hike this month would likely be the last for a while.

Capital Economics stated in a note last week, “We suspect that further signs of a significant easing in the monthly core CPI (consumer price index) numbers for July and August will ultimately persuade the Fed to hold fire for the remainder of this year particularly.”

The rise in oil prices was cited as another reason for the rupee’s decline this month. Brent crude futures have increased by about 12.5% during this month, indicating their best performance in over a year.

The USD/INR forward premiums remained relatively stable month-on-month, with the 1-year implied yield at 1.66%, given the possibility of sell/buy swaps by the RBI and a dovish outlook from the Fed.

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The financial community is keenly interested in Suzuki’s comments concerning the yen because Japan has previously intervened in the forex market when exchange rates fluctuate too rapidly. A case in point is the Bank of Japan’s intervention in September 2022, which was their first such move since 1998. This was aimed at decelerating the yen’s drop in value, an action that successfully lifted the yen by 2% against the dollar.

The Bank of Japan (BOJ), as Japan’s central bank, is primarily tasked with formulating and executing monetary policies, managing foreign exchange reserves, and supervising financial institutions. As a central bank, its mandate is to maintain price stability, tweaking borrowing rates as necessary to control inflation. It also ensures the seamless flow of money between commercial banks within its jurisdiction.

The BOJ’s intervention is crucial for balancing the supply and demand for the yen, and, by extension, the functioning of domestic commerce. While a decline in exchange rate can make a country’s exports more globally competitive, it can also make imported goods more expensive, which could potentially pass the burden onto consumers and lead to inflation. The BOJ’s intervention last year temporarily achieved its aim as market players reacted by buying yen and selling dollars. The yen rebounded from nearly 150 to 130 per dollar within a five-month period.

The yen’s weakness has largely been attributed to the Federal Reserve’s swift hiking of interest rates, which has widened the gap between U.S. and Japanese short-term borrowing rates. The divergence in these interest rates moves in sync with the currency’s movement, as revealed by the changes in the U.S. two-year yield versus the two-year Japanese yield.

The interest rate differential is a key consideration in foreign exchange trading as it underpins the forex forward rate and contributes to forward points, which adjust the spot rate to account for the cost of carrying the currency till the forward date, and drives forex trading. A favorable interest rate differential implies earning interest on the owned currency. For instance, with the U.S. Fed Fund rate at 5% and the Japanese overnight rate at -0.10%, purchasing dollars and selling Japanese yen would yield a 5.1% annual return, assuming the spot rate remains unchanged.

The spot rate is the current exchange rate at which two currencies can be exchanged. It is the rate at which a currency can be bought or sold for immediate delivery. A spot currency rate delivers currency to a counterpart within two business days. 

Fundamental analysis, which involves assessing the intrinsic value of a currency pair by examining related economic, financial, and other qualitative and quantitative factors, is used to understand currency movements. In the U.S., despite some data pointing towards a slowdown, most indicators show a strong economy. The U.S. Labor Department’s recent release of robust jobs data for May – 339,000, considerably above the expected 190,000 – boosted U.S. treasury yields, thereby tipping the interest rate differential in favor of the dollar.

Technical analysis also plays a key role in understanding currency movement. It involves studying past price actions and identifying patterns that may suggest future activities. A variety of tools are used for this purpose, including charts and moving averages, and indicators such as the MACD (Moving Average Convergence Divergence).

Currently, the USD/JPY is gaining momentum as U.S. yields rise relative to Japanese yields. The Japanese finance minister has signaled that the BOJ will refrain from intervening and let the markets determine the USD/JPY forex rates. However, the effects of a weak currency are a double-edged sword for Japan – while it could stimulate exports, it could also increase import costs, leading to higher inflation.

The U.S. Federal Reserve has increased interest rates by 5%, but the Fed Chair’s recent comments hinting at a possible pause has temporarily reduced the upward pressure on the USD/JPY. Despite this, market expectations still indicate further tightening by the Fed, with one more hike expected in July. Strong U.S. jobs data continues to drive yields at high levels, unlikely to decrease swiftly, thereby exerting continued upward pressure on the dollar. Technical indicators, too, suggest an ongoing upward trend for the dollar.

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King Dollar

The COVID-19 pandemic caused global central banks to take emergency action to support the world’s economies; one such measure was the rapid cut in interest rates to record lows.

With the recovery well underway and, pandemic-era lockdowns soon ending, inflation began to rise. In April of 2021, headline Consumer Price Inflation (CPI) in the United States jumped from just above the Fed’s 2% target to 4.2%, a more-than 12-year high!

But just before this spike, inflation in the US caused Fed Chair Jerome Powell to seek to calm markets and the public by famously describing inflation as “transitory,” a moniker that was subsequently dropped by year-end as it was clear that inflation was, in fact, entrenched.

At this time, the US dollar was trading close to the bottom of the six-year trading range, which was about the average valuation across the prior twenty years; a period that took in the 2000 dot-com bubble, the 2008 global financial crisis, and the pandemic!

In mid-June 2021, when the Fed indicated the possibility of raising interest rates by 2023, the dollar started to appreciate in anticipation of potential future rate hikes. Additionally, US government bonds experienced an increase in value across the maturity curve.

The Fed wasn’t the first major central bank to lift rates: the Bank of England (BoE) takes that crown, following hikes from Norway, New Zealand, and a few others. The Fed went aggressive, hiking in March 2022 by 25 basis points and then lifting by increments of 50 and 75 basis points until a slowdown in early 2023.

In February of 2022, Russia invaded Ukraine, causing a flight to safety in financial markets. The dollar was the primary beneficiary, gaining several per cent against most currencies. This uncertain geopolitical backdrop coupled with the Fed’s aggressive monetary tightening cycle pushed the dollar higher as far as its peak in late September 2022 after an impressive 28% increase when measured against a basket of currencies (the “DXY” US dollar Index).

Exporter advantage

The almost straight-line appreciation of the dollar against the British pound and the euro was a boon for those exporting to the US, or other countries and markets operating in US dollars. From Q3 of 2021, the euro fell against the dollar for five consecutive quarters; the pound experienced a similar fate, bar one period of very modest gains in Q4 2021, largely thanks to the BoE’s rate hike and the better-than-expected pathway through the latest COVID variant. 

With each passing month of local currency declines and dollar gains, exported products became more attractive to overseas customers and, margins increased. Remember we saw a significant rush for overseas investors purchasing properties in the UK and Europe thanks to the dollar’s strength!

Peak dollar: is the party over?

The dollar certainly peaked in late 2022 and, has been losing value every month except February, when the Fed spooked markets with strong hawkish rhetoric that was ultimately dismissed by March. The dollar’s rise took the DXY up by $25, the pound down by more than 21%, or $0.30 (if we ignore the Liz Truss mini-budget calamity and associated plunge to record lows), and the euro down by about 20%, or $0.24.

The reversal of the dollar’s gains has thus far caused the pound to regain about $0.14, and the euro to erase about $0.12 of prior losses. Both the pound and euro have recovered by around 50% from the 2021-onward slide, which we know was inspired mostly by the Fed’s (more) aggressive interest rate hikes, plus the safe-haven demand for the dollar. 

The May meeting of the US Federal Open Market Committee brought US interest rates to 5.25% and, many investors believe that the Fed will now hold rates before making an eventual cut. Of course, nobody truly knows – even the Fed policymakers, who are reacting to incoming data – but, if inflation in the US continues to ease – as we saw in the data released on 10 May –, there is a strong likelihood that the Fed is nearly done, if not already. This will very likely lead to further losses for the dollar. 

Exporters be warned

Business is never easy and, whilst I’m sure that exporters haven’t been making money hand-over-fist because of a strong dollar, I’m positive it’s helped to a greater or lesser extent for most. 

With stubbornly high inflation in the United Kingdom and sticky underlying inflation in Europe, the outlook for interest rates on this side of the Atlantic is more hawkish than in the US. 

Diverging monetary policy drives exchange rates hard and, there is a real possibility that we could see further losses for the dollar, perhaps sending GBPUSD as high as $1.30 and EURUSD to or above $1.20 across the next 12 months.

The latest interest rate from the Bank of England came on 11 May and, the Monetary Policy Committee lifted Bank Rate for the twelfth straight meeting, adding a quarter-point (25bps) and taking rates to 4.5%. The BoE stressed that further interest rate rises could be required to curb inflation and, they upgraded their GDP forecasts, erasing a prior prediction of recession this year. The good news on economic output projections coupled with a hawkish BoE are arguably bullish for the pound.

Anybody that reads my daily or weekly FX newsletters will know that I urge caution and advise strongly against using FX forecasts for any decision-making. FX forecasts are famously inaccurate and, exchange rates are affected by an extensive array of factors. Understanding the changing dynamics and being aware of the possibility that the trend could continue should inform and support better decision-making by business leaders. 

Exporting businesses should look at the pricing structure of long-term contracts, renewals, and business in tender. Stress-testing financial performance and risk management strategies against a weaker dollar is a straightforward way to assess the impact of a continued slide in the dollar’s value and, firms should look to review budgets in light of potential further dollar losses. 

A qualified and experienced currency risk consultant will be able to review the performance of a firm’s FX risk management strategy and, make considered recommendations for managing exchange rate risk effectively in a trending market. 

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