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New champion

6 August 2014 By Swaha Pattanaik

Sterling emerged as the currency market strongman over the past year because investors grew increasingly confident the UK would be the first big economy to raise interest rates. The dollar now looks set to wrest the title from the pound.

Better economic news has spurred investors to marginally bring forward expectations of when American rates will rise. Interest rate futures are now pricing in a quarter-point Federal Reserve tightening by the middle of next year, a month or two sooner than was anticipated at the end of May. Tiny adjustments have also been seen beyond mid-2015.

Something similar occurred in Britain in the past year. By now, expectations that UK rates will rise around the turn of the year are too old hat to lift the pound, which rose to nearly $1.72 in July, its highest in almost six years. In the United States, though, such shifts in rate views are more of a novelty. They could boost the dollar, even if comments from the Federal Reserve still suggest caution.

There is extra room for market moves, if investors catch up with the Federal Reserve. The Fed funds rate is expected to be 2.50 percent by the end of 2016, according to the median of the central bank officials’ latest projections. By contrast, money markets don’t see rates rising there until a year later, even after a recent upgrade of the Fed’s economic assessment.

A strong dollar is not a sure thing. The U.S. economy is healthier than Britain’s was a year ago, so strong American economic data has less scope to surprise investors and lift the currency. There are also few signs of wage pressures. But the more the market comes around to the Fed’s point of view, the rosier the outlook becomes for the dollar.

An index of the dollar’s value is at 11-month highs of 2 percent since July. A UK-style shift in market rate expectations could see it climb another 8-10 percent. There could be even more gains if geopolitical worries intensify or financial market worries suddenly emerge. After all, the dollar is still considered a safe haven in any sort of trouble.

G4 currencies’ performance in the past 12 months

Move aside sterling, a new currency strongman is emerging.

 

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