March 21, 2019

Two Currencies in a Race, Both Coming in Second

Markets were expecting a dovish tone from the U.S. Federal Reserve at its March meeting, and Fed Chair Jerome Powell certainly didn't disappoint. The Fed acknowledged slowing economic momentum and soft inflation and downgraded its economic forecast.

Additionally, the Fed signaled that it would slow the pace of its balance sheet normalization and end it completely by September. From a global perspective, a pause by the Fed gives us pause when looking at the U.S. dollar and how this changes our thoughts going forward. Those who have been following our forecasts know that we expected some weakness in the U.S. dollar after the first quarter of 2019. That view got a boost Wednesday with the Fed's moves.

What interested us was the trading action in the first few hours after the Fed meeting. There was an initial reaction of most currencies to strengthen against the greenback. The one outlier was the British pound, which lost ground as the Fed meeting happened on the same day as news broke about what the EU would accept from the U.K. in terms of a proposed Brexit delay. Essentially, pressure is building for the U.K. to either take Prime Minister Theresa May's negotiated deal, or risk a hard Brexit.

We will see if that stance softens any, but for now EU leaders' patience is getting pretty thin. Since that initial reaction however, we have not seen a great deal of follow-through. In fact, there was something of a snap back for the dollar on Thursday even as the British pound continued to lose ground into Thursday. It seems like if Brexit were not such a mess, the British pound sterling would be more stable, and all the pressure to sell currencies would be on the U.S. dollar.

Meanwhile, there is another part of the world that is having a much different experience this week. Emerging market currencies strengthened, as investors fled the low-yielding U.S. debt markets and the Brexit issue, in favor of Russia, Mexico and South Africa, whose currencies gained more than 2 percent this week.

Our View: After we get through these crazy two weeks, markets will settle down a bit, but with a new valuation paradigm. The dollar will stay on the weak side. Sterling strength will really depend on how things play out as we approach next Friday, which for now is the day the U.K. crashes out of the EU.

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