Pounding other currencies

The Dubai Financial markets index took another bash on Tuesday, and has now lost 26% in the past 6 weeks. For those who worry developed markets may be ahead of themselves, even after this fall, the DFM index has still doubled in the past year. Monday's euro zone inflation data showed no pick up with the year-on-year rate holding at 0.5%. One would imagine that it is too early to see any impact from the measures that the ECB introduced to stimulate the economy at the last meeting, but if the inflation figure remains close to the current level more pressure will be heaped on Mr Draghi to introduce similar measures to the ones the Fed have introduced.

As the 2nd quarter has now ended, the S&P 500 is up 6% year-to-date. US treasuries on the other hand are up 16%. We said at the start of the year the greed was in equities and the fear in bonds, not for the first time fear outperformed greed.

The FTSE 100 has had a sluggish start to the year for a total return of just over 2% in sterling terms. The strength in sterling will have meant overseas investors would have fared far better. The past year has seen sterling rise approximately 10pct against the US dollar, and in that time the FTSE 100 has pretty much marked time. Overseas investors will have made a decent return despite the index being flat. The appreciation of the currency has come about as speculators anticipate the Bank of England to be the first of the developed economies to raise rates. The Bank of England will probably not want sterling to rise much further. The rise in sterling could start to impact competitiveness and profitability, and in turn this could put the recovery itself under pressure. It may also in turn keep inflation in check, taking the pressure of the Bank of England to raise rates.  

Croda a specialty chemical company recently lowered its forecasts for profits, blaming the rise in sterling. Burberry, Asos and Wolseley have also warned that profits will be impacted by the strength of sterling. So many of the FTSE 100 companies rely on exports for revenue; Croda for example exports 95% of its products. Normally, currency effects can balance themselves out, but the Croda CEO at the analyst meeting post warning announcement, indicated that sterling has been strong against all the major other currencies, compounding the problem. The other area where a stronger currency can have an impact is in mergers and acquisitions, as the acquirer has to pay more for its currency making any acquisition of a UK company more expensive.

Posted on July 2, 2014 .