Currency Analyst since 2010

How will fiscal stimulus influence currencies?

Even if you are an intraday trader, you need to understand the big picture and foresee where the market is going. Being able to identify long-term trends is a vital skill for those who are serious about trading.

For a long time, the key tendency was for the central banks all over the world to loosen policy proving monetary stimulus to national economies and making national currencies depreciate. The regulators cut interest rates to record lows and adopted non-standard tools in form of asset purchases, known as quantitative easing (QE). It turned out that although some positive results of such policies were evident, these measures, though enormous in size, failed to make the economies strong enough to withstand challenges without further support. Loose monetary policy became less and less efficient: at this point in time global economic growth is weak and growth of some key economies like China is slowing down. Moreover, excessive monetary stimulus led to high valuations of stocks and other market asymmetries. Balances of central banks have spiked and so did the ratio of public debt no GDP. Obviously, there’s no way such dynamics is sustainable – monetary authorities won’t be able to keep flooding financial system with cheap money forever and the moment when they will have to stop is getting closer.

Source: Barclays

So, something has to change and analysts of Deutsche Bank, Barclays, HSBC, Credit Suisse, Morgan Stanley and Bank of America Merrill Lynch believe that the new trend will be the switch from monetary easing done by the central banks to fiscal easing done by the governments. According to these large investment banks, the recipe of economic success is the combination of fiscal stimulus and normalization of monetary policy.

What does fiscal stimulus mean? To put it simply, it implies an increase in government spending and expansion of budget deficits. In this scenario governments should target spending on most growth-generating projects, so that the boosted economic growth will be higher than the increase in debt and debt/GDP ratio will decline.

As for the US, both Hillary Clinton and Donald Trump favor increased spending. However, the victory of Hillary Clinton, which now looks more likely, will probably be accompanied by the divided Congress – mixed Senate and a diminished Republican majority – so it might be difficult for her to pull though a large fiscal package. In his turn, Trump has often criticized the Federal Reserve for low interest rates and, if he wins, there will likely be large tax cuts and increase in budget spending. If America does fiscal stimulus, the Fed will have to raise interest rates faster and US dollar will strengthen.

In the euro area there may be political obstacles to fiscal stimulus. To succeed there should be coordinated action from all the region’s governments, which can be difficult to achieve. There are also risks that the situation will get out of control in the euro area’s peripheral nations making the ECB keep monetary policy loose or ease it even more. As a result, the effect of fiscal stimulus in the region should be moderately bullish for the euro, but the risks mentioned above should be taken into account.

Fiscal stimulus in the UK would be a positive factor for the British pound. However, last week Chancellor of the Exchequer Philip Hammond played down the likelihood of big fiscal stimulus package in response to Brexit vote on November 23, when he will deliver his Autumn Statement. In the longer term, however, Britain may have to do fiscal stimulus as the nation ultimately pulls out of the EU. For a start, the UK no longer plans to tighten fiscal policy and achieve budget surplus and this should be of a help to British economy and decrease bearish pressure on the pound.

In Japan it will be much more difficult to encourage an increase of demand through increased government spending as the households tend not to spend, but to save money, so potential of growth in Japanese yen will be limited. In addition, the yen will be hurt if the nation’s current account deteriorates. 

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