What Happens To Forex Markets After QE?

With the financial crisis receding the focus is increasingly shifting towards the normalisation of monetary policies and this could bring back some familiar patterns to the currency markets – eventually.

The Bank of England has already ended its quantitative easing programme, the US Federal Reserve is winding its one down, the Bank of Japan is exploring the possibility of doing so and the Reserve Bank of New Zealand has actually been raising its official cash rate.

The only big exception is the European Central Bank. It is fretting over a potential deflation problem. However, if monetary policy continues to normalise around the world and economic growth is becoming more entrenched then the ECB may not have to be that interventionist and not for very long. Global growth should quell deflationary pressures.

Traditionally among the key drivers of currencies are interest rates, bond yields and inflation. Since 2008 these have been superseded by quantitative easing and attempts to manipulate exchange rates to favour exports. But in a more 'normal' environment these fundamentals should once again play a bigger role in driving exchange rates. 

EUR/USD – still being influenced by aggressive central banks

Reviving the carry trade

If markets do steadily shift towards being more driven by fundamentals as interventionist central banks start to step back then strategies such as the carry trade, which was a feature for many years before the crisis, are likely to make a return.

Also a more dynamic global economy favouring international trade would see central banks being less concerned about exchange rates – that would favour currencies being able to trend further and for longer.

However, though there's definitely light at the end of the tunnel the global economic environment is by no means 'normal' yet. There are still things that could go wrong. There are question marks over the sustainability of Japan's recovery, China could still have a financial crisis and the Eurozone still faces big challenges.

But for the time being at least the direction of travel appears to be positive.

By Justin Pugsley, Markets Analyst MahiFX

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