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Global uncertainty and volatile currency markets could give edge to exporters


Justin Doyle

Justin Doyle

Philip O'Sullivan,  Investec

Philip O'Sullivan, Investec


Justin Doyle

Concerns about a Eurozone slowdown, geopolitical tensions and Ebola all injected a dose of uncertainty to markets in recent weeks.

A number of other potential 'speed bumps', ranging from the UK general election through to the implementation of new policies by the world's largest central banks, will also need to be carefully navigated.

But, as Investec's Philip O'Sullivan and Justin Doyle outline, while the backdrop has become more unsettled, on balance the outlook for Irish exporters remains favourable.

The outlook for two of our largest trading partners, the US and UK, is positive, with recent dollar and sterling strength providing an added kicker for Irish exporters. Chasing non-Eurozone business in more volatile times is not going to be without its risks, so vigilance and strategies to protect against adverse developments are warranted.

Since the start of 2014 the US dollar and pound sterling have risen by 11pc and 6pc respectively against the euro. As we recently outlined in our latest Investec Irish Export Monitor, this is positive news for Irish firms selling into those two markets (that account for a combined 37pc of merchandise exports and 28pc of services exports), which augments a healthy growth story for both economies (Investec sees US and UK GDP rising 3.4pc and 3pc in 2015, following expected growth of 2.2pc and 3.1pc this year).

The picture is, unfortunately, less encouraging for some of our other trading partners. Indeed, as we approach the year end it is clear that the global backdrop has become more unsettled.

The IMF recently trimmed its 2015 global GDP growth forecast to 3.8pc from 4pc, citing factors such as geopolitical tensions, financial market risks (the CBOE Volatility Index, or VIX, recently hit a two-year high), low potential growth in a number of advanced economies and deteriorating prospects for several emerging markets.

The IMF is particularly worried about the Eurozone, placing a 40pc probability on the currency union re-entering recession, while also reducing its 2014 and 2015 growth forecasts for it to 0.8pc (from 1.1pc) and 1.3pc (from 1.5pc) respectively.

Given the divergent growth trends noted above, it is no surprise that monetary policy in the Eurozone is expected to move in the opposite direction to the US and UK.

Thus, we expect the euro to continue to weaken against both the dollar and sterling (we see EURUSD and EURGBP at $1.22 and £0.77 by end-Q1 2015). This will bring more good news for Irish-based firms invoicing in those currencies, although it is potentially problematic for firms with inputs priced in non-euro currencies.

So, while our sense is that Irish exporters should, on balance, continue to benefit from improving demand across the majority of our largest trading partners, the coming months could see a number of speed bumps, ranging from the market's reaction to central banks' policy moves, to political risks through to a potential escalation in the current tensions in parts of EMEA.

These event risks mean that it is advisable for Irish firms to exercise vigilance and consider strategies to protect themselves against any adverse developments.

Turning to the prospects for sterling, it has had something of a bumpy ride in recent months due to factors such as the Scottish independence referendum and some slightly more dovish comments from the Bank of England (BoE). While the Scottish question has been settled for at least a decade, other political events are preparing to take centre stage, with Prime Minister David Cameron gearing up for a showdown with Brussels over its £1.7bn Budget demand (presumably with one eye on UKIP's poll ratings) and next year's general election (due by May 7 at the latest) on the horizon.

This all means that further sterling strengthening will be harder to come by, but nevertheless with a worsening European economic situation and an expected BoE rate hike in August 2015 we feel that a EURGBP rate of close to £0.77 is very achievable in the short to medium term.

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For the greenback, the Fed recently concluded its QE3 asset purchase programme, which sent dollar bulls on a renewed charge.

In terms of the outlook for EURUSD, while it should take a few months at the very least for the new ECB stimulus to kick in, in any event we feel that stable US labour, inflation, equity and (to a lesser extent) housing markets will push an increasingly hawkish Fed to act sooner rather than later.

We have modestly upgraded our US growth forecasts to 2.2pc this year (2pc) and 3.4pc (was 3.3pc) for 2015. Our forecast for the timing of the first Fed Funds target rate hike remains Q2 2015. With this in mind, we feel it is not beyond the realms of possibility that the euro could weaken further into the crucial $1.19/$1.21 support region sometime in Q1 of 2015.

We think these are very attractive levels (five-year lows) and we have consistently advised clients who need to sell dollars to at least consider hedging some of their more medium to longer term dollar exposure in or around these levels.

For dollar buyers, $1.30 is the new $1.40 and we would encourage clients importing from the US to take advantage of any move above the key $1.30 level if and when the situation arises.

In all, while the overall outlook remains positive, the coming months are likely to be volatile ones for currency markets.

Volatility is not necessarily a threat, as well designed and executed hedging strategies can allow Irish exporters to lock in higher profits while protecting against adverse developments. This is particularly important at a time when many firms will need to take on currency risk if they want to look beyond the sluggish Eurozone and take advantage of the stronger growth prospects for many non-euro countries.

Philip O'Sullivan and Justin Doyle are Chief Economist and Senior Treasury Dealer with Investec Ireland.

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