Saturday 22 October 2016

Exporters should make hay while the sun still shines

Justin Doyle

Published 29/10/2015 | 02:30

Mario Draghi, president of the European Central Bank (ECB). Photo: Bloomberg
Mario Draghi, president of the European Central Bank (ECB). Photo: Bloomberg

Central Bank announcements have always been keenly followed by participants in the various asset classes over the years. However it's only really when markets forecast and price in a U-turn in policy that 'Central Bank gazing' hits the now frenzied levels we have witnessed in recent months.

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This year had been set apart as the year that at least some of the major Western (Fed & BoE in particular) monetary policy makers would hopefully begin to turn their backs on the ultra-accommodative practices that have been in place since the 2008/2009 global financial crisis.

At the outset of the year the general consensus in the FX market was crystal clear; diverging monetary policies (ECB to loosen with the Fed and BoE preparing to tighten) would see the euro continue to weaken against a resurgent dollar and sterling.

One element of that equation has materialised but the other two are stubbornly close to not being realised. So following on from the ECB signalling and subsequently announcing their (€60b, 18 month) QE programme, FX markets witnessed an almost vertical drop (25pc to $1.05 & 14pc to £0.70) in the value of the euro in the second half of 2014 and the first quarter of 2015, the single currency did turn heel during the summer months as European inflation stabilised and shaky Chinese markets took it back towards the $1.17 and £0.75 levels.

As we approach the turn of the year, it is clear that the outlook for all jurisdictions (growth and inflation in particular) for 2016 has become more uncertain.

The narrative around economic data releases from Europe but more importantly the US and UK - key trading partners for Ireland - has shifted from 'unambiguously positive' to 'somewhat mixed'.

The picture is so murky in fact, that it was only last Thursday when ECB President Mario Draghi highlighted the downside risks emanating from emerging market growth prospects pointing to possible adverse effects on Eurozone exports, as well as financial market stress, which could weigh on domestic demand.

The ECB is extremely mindful that any economic recovery will be export driven and as such Mr Draghi and his foot soldiers are doing everything within their mandate to drive the value of the single currency lower in order to boost export competitiveness and haul inflation levels back closer to their 2pc target.

A 'vigilant' Draghi didn't go as far as announcing an extension of the ECB's current QE programme but much to the cheer of European (and Irish) exporters he as well as signalled some action at their next meeting on December 3rd.

By that time the ECB will have two (October and November) more inflation prints at hand and if they happen to follow the September sub-zero shocker, the ECB will announce some monetary stimulus from the 'whole menu' at their disposal.

It wasn't a total surprise then that the euro nosedived yet again in the few days following Draghi's press conference last Thursday. Our central case is that the ECB will add more monetary stimulus in the next few months and with the short term inflation picture looking so dismal, December 3 seems increasingly like the most natural date.

On the nature of that stimulus though, a QE boost is still perhaps the most likely but the list of possible instruments on the table has lengthened.

As a newly emboldened ECB continue to battle the deflationary beast and with current exchange rates at such attractive levels ($1.10 and £0.72) the question remains for Irish exporters… how low can it go?

In a perfect world the ECB/Fed & BoE monetary policy divergence would continue unabated and the previously unmentionable rate of $1.00 and sub £0.70 would now be in the crosshairs but as seasoned market watchers are only too aware markets don't move in straight lines. The recent equity wobble surrounding Chinese growth concerns only serves to remind us how fickle the FX markets really and there are just a few possible speed bumps around the corner.

Between now and the next ECB meeting we have a hugely important Federal Reserve meeting/announcement, a BoE Quarterly Inflationary Report and two European inflation prints. So to say there's a lot to contend with is probably stating the glaringly obvious.

The timing of the first Fed hike is being clouded by some Sino-American finger pointing (The Fed consistently cites slowing Chinese growth as a major reason for deferring its long-awaited rate hike) and the BoE is being held back by a similarly deteriorating inflation scenario which could throw up a surprisingly dovish QIR in early November.

With this potential event risk in mind it may not be the worst advice to just 'make hay while the sun shines'. For Irish exporters and currency sellers a sub $1.10 and sub £0.72 are seriously attractive levels ahead of what we think will continue to be a seriously volatile few months in the currency markets.

Justin Doyle is Senior Treasury dealer at Investec

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