BAFI1002 Financial Markets Review View For Lower Rate

To complete the market view, you are required to analyse one currency pair out of the following currencies: AUD, USD,  JPY, EUR and GBP.

 

You can choose any combination of these currencies, so something like AUD/USD and AUD/JPY is acceptable, and so is AUD/USD and JPY/GBP. You are required to analyse what will happen to these exchange rates in the next 3-6 months. Based on the theory that you have learnt in class in the FX topic (exchange rate determination), you are required to analyse these exchange rates based on the economic indicators of the respective countries. The indicators you learn in this subject include relative interest rates, relative inflation rates, relative growth rates, government intervention and exchange rate expectation. You may also use other factors that may affect the exchange rate (e.g. commodity prices in Australia). It is a  good idea to use at least three of the indicators that you have learnt in class if you want your market view to be strong. In your analysis, if you have looked at a particular indicator, you must write why you believe that this indicator will cause a currency to appreciate or depreciate against another.

Answer:

Introduction 

Foreign Exchange Market is one of the largest financial markets in the world. The US and UK market shall account for majority of the transactions. The majority of transactions occur at London, New York and Tokyo. Foreign market participant generally enter the market with an intention to hedge or speculate or make an arbitrage gain. 

The following macroeconomic factors have been analysed to determine the prospect of currency in near future: 

• Relative Interest rate: A higher rate of interest rate prevailing in a country generally results in  a higher value of a currency compared to country with a lower rate of interest. It is one of the major factors that influence the exchange rate of one currency in terms of another. 

The above phenomenon occurs on account of attraction of foreign investment as higher interest rates attract investors resulting in demand for the currency and corresponding increase in the price of currency. Currently, the rate of interest prevailing in USA as proposed by FED is 2% (TRADING ECONOMICS, 2018)while the rate of interest prevailing in UK is 0.5 % as proposed by Bank of London (Bank of England keeps interest rate at 0.5%, 2018). Thus, on the basis of the same, US dollar shall rise compared to GBP. However, there are multiple other factors that need to be harped on for deciding future prospects. 

• Relative Inflation rates: The term inflation generally means increase in prices of goods and services in a country over a defined period. It has a general impact on foreign exchange rate of a country in terms of another. A higher inflation rate in the economy is a symbol of falling foreign exchange in the future as proposed by chief economist David Ricardo under his theory of Law of one price in 19^th 

The above phenomenon generally occurs on account of lowering of basket of good purchased with 1 unit of currency on account of increasing inflation in the economy. While for the cross currency the basket of goods shall be higher resulting in rise of currency rate for a country with a lower inflation rate. Under, the present scenario, the inflation rate in America is 2.9 percent as on July, 2018 (highest since February, 2012) while the rate of inflation prevailing in UK is 2.6% (Consumer Price Index is  2.4% in May). Thus, in terms of the aforesaid theory, the prices of GBP shall rise in terms of US Dollar. 

• Relative Growth Rates:The Growth rate of economy i.e. GDP is an important indicator of foreign exchange rates. The higher the rate of growth of the economy the stronger will be the currency compared to other. Thus, a stronger GDP is an indicator of a healthy economy and a strong currency. 

The above phenomenon generally occurs on account of increasing competitiveness, increased production of goods and services and strong economic performance. Currently, the rate of growth of US Economy is 4.2 % as on July, 2018 while the rate of growth prevailing in UK is 0.4%. Thus, UK economy has been growing at a much slower pace compared to US economy. 

• Technical Factors: Onthe basis of technical analysis and tools in the form of graph, charts and other associated tools, it can be derived that value of USD shall rise compared to GBP on account of strong up support and favourable economy. The analysis has been presented here-in-below:   

On the basis of above, it may be understood that prices of dollar against GBP shall stand at 0.75 by 2023 and it shall strengthen by 2,25% in a year. (Walletinvestor.com, 2018)

 Political Scenario: The political scenario currently prevailing in UK is a disturbed with major issue being Brexit (Britain Exit from European Union) causing a weak sentiment towards the GBP currency in the global scenario. Investors are losing confidence under the present scenario resulting in weakening of currency in the nearby future. The same shall result in a staggering loss to the currency. Further, many business houses are pulling out of the economy entirely resulting in lower GDP and falling demand for the currency. 

In the USA Market, similar tension and problem persists with Mr. Trump, the honourable President of USA taking stern decisions to overturn the world economic order. The major decisions recently undertaken including firing of major members of his cabinet, withdrawing for Paris climate convention, backing out of Iran deals, trade wars etc. 

Thus, the aforesaid measures have a negative impact on both currencies. However, the impact of Brexit is haunting the UK economy and is a major cause of concern for European Union. 

• Market Expectations:  The market sentiments playa very crucial role in determining the short term prospect of a currency compared to other. In the near future, the fear of Brexit being heightening and soft manufacturing in Britain a negative market sentiment seems to overshadow the Pound sterling with a near term fall against the US Dollar. 

The matter shall be further worsened with recovering American economy from slowdown and rising FED rates attracting global investments. 

Thus, on the basis of the above analysis it may be worthwhile to come to a conclusion that GBP shall fall compare to American Dollar in the near future on account of aforesaid factors. Thus, as a speculator in the near term, I shall propose to go long on USD and short on GBP making margins out of speculations. Further, for a hedge I shall propose to mitigate the exposure on account greater uncertainty prevailing in the global market and strong economic decisions undertaken by leaders of both the jurisdiction creating impact on respective currencies.      

Bibliography 

Bank of England keeps interest rate at 0.5%. (2018, May 10). Retrieved September 4, 2018, from www.independent.co.uk: https://www.independent.co.uk/news/business/news/uk-interest-rates-latest-update-bank-england-pound-sterling-price-latest-mark-carney-a8344691.html

TRADING ECONOMICS. (2018). United States Fed Funds Rate. Retrieved September 4, 2018, from tradingeconomics.com: https://tradingeconomics.com/united-states/interest-rate

Walletinvestor.com. (2018). Is "United States Dollar / British Pound Sterling" Pair a Good Investment? . Retrieved September 4, 2018, from walletinvestor.com: https://walletinvestor.com/forex-forecast/usd-gbp-prediction