12/01/2016
Central Bankers Rattle Currency Sabers to Keep FX Rates Weak
Central bankers around the world may be sharing the same New Year’s resolution: a weaker currency.
Whether spoken or unspoken, policy makers appear to be turning to depreciating exchange rates as a route to stronger demand and inflation as other stimulus tools run out or fall flat.
Just last week, China’s currency policy rocked global markets for a second time in five months as authorities allowed the yuan to slide. That drew a warning from Mexican Finance Minister Luis Videgaray that the world faces a renewed risk of competitive devaluations.
In the meantime, Sweden’s Riksbank said it’s ready to intervene to limit gains in the krona, while Swiss National Bank President Thomas Jordan reiterated a pledge to keep the franc in check almost a year since he gave up a currency cap.
De-Facto Targeting
Officials at major central banks may also have exchange rates at the forefront of their minds. Even as the Federal Reserve raised its benchmark last month, officials including Vice Chairman Stanley Fischer noted the dollar’s surge since mid-2014 had previously helped stay their hand.
At the European Central Bank, President Mario Draghi noted last month that the euro was “important for price stability and growth” as he increased stimulus. A rising yen may force Bank of Japan Governor Haruhiko Kuroda to consider more quantitative easing. Bank of England Governor Mark Carney turned more dovish after the pound rose last year on speculation the U.K. would soon follow the Fed in hiking.
There is a “new global regime of de-facto FX targeting by many central banks which — unannounced and uncoordinated — causes additional damaging volatility and uncertainty in markets and for businesses,” Erik Nielsen, chief global economist at UniCredit Bank AG, wrote in a report to clients on Sunday.
What Nielsen calls a system of “managed floating” exchange rates may backfire for the world economy given one country’s gains on the back of a cheaper exchange rate will likely be offset by softer growth in its trading rivals.
Past pain is behind China’s increased willingness to depreciate the yuan, according to George Saravelos, a strategist at Deutsche Bank AG in London. That may be a topic of increased discussion given China’s role as chair of the Group of 20 this year.
Feedback Loop
“The Chinese economy has suffered because the currency has been fixed to the dollar even as the rest of the world has been busily devaluing,” Saravelos told clients last week. “China will no longer tolerate competitive devaluations from the rest of the world.”
A falling yuan may in turn mean the likes of the BOJ and the ECB will have to add more and more stimulus if they want to lower their exchange rates, he said. The Fed may need to scale back the amount of rate increases it envisages.
Not all central bankers want to push their currency down. Mexico and Colombia would like their exchange rates to strengthen, while a fall in the rand to a record low has spurred speculation the Reserve Bank of South Africa will respond.
Disputing whether a currency war has broken out, Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co, also says the dollar’s trend is still up, the yen outpaced rivals for the past six months and the yuan hasn’t fallen that much on a trade-weighted basis.
Not Zero-Sum
“Every time a country ease monetary policy to help reflate its domestic economy, and its currency falls, it cannot be fairly accused of pursuing beggar-thy-neighbor policies,” said Chandler. “Cutting interest rates is not zero-sum. It can help facilitate an increase in domestic demand, some of which may be for foreign goods and services.”
Still, feedback loops are on the minds of strategists at HSBC Holdings Plc, who estimate the sensitivity of foreign-exchange traders to interest-rate expectations is at its highest in 15 years.
That means any central bank looking to tighten monetary policy runs into a strengthening currency, resulting in disinflationary forces, which may prompt it to rethink the original plan. In the case of the Fed, that could limit rate increases to two rather than the four officials now plot, according to HSBC.
“A successful monetary-policy normalization may have to wait until the major economies can tighten together,” strategists led by David Bloom said in a report last week. “Currencies are constraining the plausible path of interest rates in the future,” they said. “The risk is that we see an escalating series of policies, where at least part of the aim is to weaken the currency.”
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