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Dean D’Sa : “We now face another potential seismic decision in France”

Edition Number: 
Dean D’Sa
"The great British pound does not look so 'great' following the Brexit vote"
From Date: 
Mercredi 12 Avril 2017
To Date: 
Mardi 18 Avril 2017

In the light of the latest political events, the dollar could strengthen further against the euro and the pound sterling, observes Dean D’Sa, the Advisor to MCB Treasury.

BUSINESSMAG. What could be the impact of a firming up of interest rates in Europe and the US on the Forex market?

To be honest, I personally don’t think the European Central Bank (ECB) is going to raise interest rates anytime in the near future. However, we have just seen the Federal Reserve (Fed) hike rates to 1.00% and the rhetoric from Fed governors suggests they are looking to hike rates two or three more times this year. With this in mind, I would expect the EURUSD currency pair to move lower in the medium term because the interest rate differential between countries has proved to be one of the biggest contributors behind the direction and magnitude of moves in foreign exchange markets.

Look back to June of 2016, investors were expecting that in December 2017, the interest rate in Europe would be -0.40% whilst in the US the interest rate was expected to be 0.8%. A differential of 1.20%. Move forward to today, the interest rate differential has moved higher to 1.90% as the interest rate expectations have changed, and so in Europe, (contrary to my belief) the interest rate is now expected to be -0.25% by December 2017 whilst the interest rate in America is expected to be 1.65%. This change in differential has been a key driver behind the move in EURUSD from 1.15 at the time to 1.05 earlier this month.

I personally think EURUSD is likely to trade between 1.04 and 1.10 whilst the market digests the two key issues at hand - which are French elections and President Trump's ability to push through his tax reforms and fiscal policy initiatives.

BUSINESSMAG. With the Brexit now well on its way, according to your observations till when and to what extent will the pound sterling continue to fall and/or face downside pressure?

The Great British pound does not look so “Great” following the Brexit vote. It has fallen from 1.48 against the USD to the 1.24 region where it currently sits. There is a lot of bad news priced into the British Pound and all this happened before Article 50 of the Treaty of Lisbon was triggered on March 29. It is hard to say whether Brexit will be good or bad for the UK economy - as all we know right now is that the way things are presently is not going to last for more than two years. The intraday movement in sterling on the March 29 was ‘normal’ as all the information we know so far is already factored into FX rates. Indeed, nobody actually knows what agreement the European Union will have with the United Kingdom and both regions are trying to position themselves as the best place to be located for the banking, insurance, asset management, pharmaceuticals, and indeed the automobile sector. There is a lot of uncertainty surrounding Brexit for both Britain and Europe.

My personal view on GBPUSD is that financial markets have already priced in a large proportion of the bad news and thus we are relatively close to the bottom end of the range that we will see this currency pair trade. Personally, I think GBPUSD will move lower to 1.15 and it may reach 1.10 but I don’t expect it to go lower after that.

BUSINESSMAG. We have seen a weakening of both the euro and the dollar against the rupee over recent months. What would this mean for Mauritius if the trend is maintained?

This has been the traditional view but let’s be fair. This type of movement in FX markets has been in place since 2014, but the Bank of Mauritius looks to have handled the situation well through amongst other things its regular interventions in FX markets and associated sterilisation. As a result, headline inflation (as measured by the consumer price index) has been maintained below 2.0% since June 2015 which has enabled the Key Repo Rate to be brought down to 4.00% to help stimulate the economy. Further to this, commercial banks have also been offering novel hedging solutions to clients which has allowed them to mitigate some of the impact from these currency moves. Bear in mind, Mauritius is part of the global ecosystem and thus the evolution in oil prices over the same time period has also contributed to alleviating headwinds.

BUSINESSMAG. Beside the global slowdown, there have been major political shifts in the world lately. How markets are reacting to these events?

The political shifts we have seen in the US and UK are seismic and I honestly don’t think anyone can accurately identify what the ramifications of these changes will be on FX markets in the long term. Indeed we now face another potential seismic decision in France. There is a risk of a Le Pen presidency which could change the European Union as we know it given she has stated a willingness to pull France out of the EU and bring back the French Franc. This is likely to be a major cloud over the Euro and is likely to act as a headwind against any strengthening of the Euro against other currencies. However, if Macron were to win the election, there is scope for a relief rally in the Euro which could see EURUSD move back up to the 1.10 - 1.15 region whereas a Le Pen victory could easily see EURUSD move close to parity.

BUSINESSMAG. What is the impact of these changes on hedging strategies?

The options available to Mauritian corporates wanting to hedge have developed considerably over the last few years and I would therefore recommend any corporate concerned about these risks to talk to their bank about the ways in which they can hedge away any unwanted risks.

Hedging introduces certainty in decisions, but also has a cost. Corporates need to assess whether that cost makes sense for the risks they are hedging away. Personally, if I were a corporate that would see a negative impact on my PNL from a strengthening in GBP or EUR, I would probably investigate how to hedge those risks and then try and identify the right time to put those hedges on (now may not be that time). On the other hand, if a weaker EUR or GBP would weaken my PNL, I may be more willing to stay unhedged at current levels (against USD) because of my view on these currencies.

BUSINESSMAG. The election of Marine Le Pen in France might be a severe blow to the future of the Eurozone. At the same time, Nobel Prize winner Stiglitz stated that since 2008, European economy has been dragging down the world economy and euro as a common currency is threatening the future of Europe. Do you think that the euro as single currency should be maintained?

If you look at the questions you raised in this interview and indeed think about the questions in the minds of most of your readers, it is about the movement in currencies and the uncertainty it creates for decision making whether at an individual, corporate or governmental level. One of the key messages the previous ECB President Jean Claude Trichet used to reiterate to market participants was that volatility in currency markets was unwarranted as it hampered economic stability and growth.

A single currency for such a large trading bloc is advantageous to companies who do the bulk of their business within the bloc as they have no currency risk. That being said, a single currency can’t work without a single monetary policy and that is where I believe there is a problem. Each country’s business cycle has a different wavelength and so it’s just a matter of time until the monetary policy needs of Eurozone countries diverge. We have seen this frequently since the financial crisis. Indeed, the monetary policy stance of the ECB may be appropriate for Spain, Italy, Greece etc. but it is definitely not right for Germany. Thus for Europe and the Euro to work, I think a fix for this problem needs to be identified.

Magali Frédéric

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