HSBC's David Bloom is out with a interesting new research note:
A new era for FX
In the glory days of carry, the FX market had the luxury of a clear framework for understanding and trading currencies. In the low inflation environment, higher short rates meant a stronger currency and vice-versa. For the bond markets higher short rates were ambiguous for the shape of the yield curve and for equities it depended on where one was in the economic cycle. FX was beautiful. It was clear, liquid and transparent. Once we were kings and at the top of the food chain.
Today carry’s hold on FX has waned as global rates gravitate towards zero, forcing the FX market to react instead to the far more ambiguous implication of QE. By contrast, other asset classes, notably equity markets, provide a cleaner mechanistic link between a given view and a price.
In this report we examine some of the new linkages that are developing based on the perceived transition mechanisms between QE and the FX markets. The conclusion is that even if we knew the outcome of future events with certainty, the FX market is not the best place to reflect those views. We have fallen to the bottom of the food chain.
4 US: QE = USD negative : Resultant “risk on” mood takes us to higher yielding more risky currencies. “Risk off” and the USD’s safe haven status kicks in.
4 Eurozone: QE = EUR positive : Non-conventional easing as lowering the probability of EUR default and disintegration, thereby boosting the EUR.
4 Japan: QE = mild JPY positive: JGB purchases have little JPY effect, but equity market boost encourages foreign capital inflows.
4 UK QE = GBP neutral: Little currency impact as un-conventional monetary easing seen as an appropriate mirror to the ongoing tightening in fiscal policy.