Currency trading is inherently risky. As the world’s most actively traded market, analysts estimate a global daily trading volume of some $5.1 trillion according to the BIS (Bank for International Settlements). While impressive, the daily average plunged 5.5% from $5.4 trillion per day in 2013. Regardless, no other financial markets come close to currency trading. At the heart of currency trading activity is market sentiment. Many factors drive FX rates notably: geopolitical uncertainty, fiscal policy, monetary policy, and macroeconomic indicators. Central banks rank among the most important determinants of a currency’s exchange rate value.
Presently, currency traders find themselves at an interesting juncture. The Federal Reserve Bank (Fed) is looking to increase the federal funds rate by 25-basis points on Wednesday, 13 December 2017. According to analysis from the CME Group, the likelihood of a rate hike in December is now 86.7%. Market participants are growing increasingly confident about the Fed’s determination to raise the FFR to 1.25% – 1.50% before the year is out. As a currency trader, any increase to the FFR will likely boost the value of the USD, even marginally on global markets.
This means that currency pairs such as the USD/ZAR, GBP/USD, EUR/USD will shift slightly in favour of the greenback. Foreign buyers/sellers of currency will go long on the US dollar and short on other currencies. Weiss Finance trading expert Sarah Montgomery has seen a sharp uptick in GBP/USD trading. “Recently, Prime Minister May and leading cabinet members took an active position in pushing Brexit talks in Europe. Whether this has the desired effect of showing effective leadership remains to be seen. GBP rallied on the back of this initiative, and talk of Mark Carney’s proposals to raise interest rates in 2018. This bodes well for Sterling bulls.”
Experts Go Short-Term Bullish on Sterling
The flipside of the coin relates to the other currency in dollar pairs. For example, the GBP/USD is equally dependent on sterling as it is on the USD. Recent activity in the United Kingdom indicates that BOE governor Mark Carney is leaning towards a rate hike in 2018. Current conditions in the United Kingdom are such that the latest inflation rate of 3% (up from 2.9% in August) is a concern for the UK. As it stands, real wage growth is increasing at just 2.2%, outstripped by inflation by 0.8%.
This means that the real purchasing power of sterling is declining in the UK. This is being driven by Brexit stresses, shaky internal dynamics in the UK, and an inability to reach consensus on Brexit negotiations. As such, the BOE must act to stabilize sterling by raising interest rates. This will drive trader sentiment in favour of the GBP, strengthening its and making imports relatively less expensive.
GBP Subject to Greater Volatility Than USD
For currency traders, both sides of the equation need to be evaluated before an overall perspective can be garnered. If the Fed and the BOE raise rates, the theoretical effect of such quantitative tightening will be a gradual improvement for both currencies. In reality, this rarely happens. What is more likely is that any possible price movements in currency pairs with the GBP/USD will already be priced into the market well ahead of time. We may see slight upward adjustments in the strength of the USD heading into December. The GBP however is subject to greater volatility, and could spike as high as 1.35 if positive news surfaces about bank rate hikes.
