Currency Games

Currency games are back. With monetary and fiscal policy divergences growing, the US FED leading the monetary dance, and few countries able to follow, imbalances are in their growth phase. Let’s investigate the real impact of these currency games on the global economy.

The Bank of Japan, at the request of the Ministry of Finance, halted a sliding Japanese Yen currency against the USD last Thursday, September 22. The market intervention took place after the central bank communicated a no-change to its extremely accommodative monetary policy. The USDJPY fell by about 3.7% from 145.85 to a low of 140.35. By the end of the week, USDJPY closed at 143.31, confirming the reputation that FX interventions bear little effect. Especially single central bank FX intervention, looking to slow or reverse the pace of depreciation, can only become effective if shortly followed by a change in official monetary or other policies. Kuroda, the current Bank of Japan (BoJ) chair, will end his term in April 2023. Does he leave the decision to walk away from yield curve control (YCC) to his successor? Or does he tinker with yield curve control (YCC) by controlling for the 0-to-5-year part of the yield curve instead of the 0-to-10-year part? Japan’s FX reserves sit at a lofty USD 1.175 trillion. However, if they want to refrain from depleting this war chest, they will have to raise USD through the sale of US Treasuries followed by selling USD thus propping up the yen. Headline inflation sits at 3.00% whilst core inflation prints at 1.6%. Both will have to print above such levels for at least three months in order to trigger the BoJ into a change on their yield curve control policy. Markets imply that the official Bank of Japan policy rate will climb from -0.10% to +0.10% by June 2023. Compared to other OECD central banks, it seems that the BoJ governors are from Mars. The BoJ has successfully defended YCC over the past 6 years. Expect a more difficult contest in defending the bullish USDJPY trend. USDJPY at 150 attracts.

Are European central banks in panic mode? It seems that they all get impatient as proven by the bold decisions from the Swedish Riksbank to hike by 100bp and the Swiss National Bank to raise policy rates by 75bp. Notwithstanding, the SEK weakened forcefully against the EUR in the wake of that decision, whilst the CHF strengthened to new, multi-decade highs against the euro. Currency tensions are on the rise. The JP Morgan FX volatility index is breaking out to the upside. Adopting for a modest and measured rise of 50bp by the Bank of England created havoc in the gilt market next to an uncontrolled slide in GBP. This double whammy seems to have legs. Indeed, the fiscal initiatives from the Truss government greatly worry gilt investors. Two-year gilts rose by more than 40bp to close at 3.90% on Friday. Ten-year gilts suffered a blow of 33bp, closing 33bp higher at 3.82% piercing through 10-year US rates. At the start of the week the sell-off accelerates with 10-year gilts hitting 4.12%. The UK Debt Management Office (DMO) is perplexed, the market even more. EURGBP is bound to test the 0.95 resistance whilst cable (GBPUSD) zooms in on parity. The dollar index (DXY) at 113.75 is eyeing 120.

At the same time USDCNY, at 7.16 today, is trending steadily and merrily towards the double tops made around 7.19 over 2019 and 2020. What target has the People’s Bank of China (PBOC) in mind? Does 7.50 or 8.00 on the USDCNY soothe the impact of the real estate debacle on top of the manufacturing stop-and-go behaviour linked to a zero-COVID policy. The beggar-thy-neighbour FX results are increasing. Depreciating one’s currency next to adopting policies that protect the domestic economic fabric are often on expressions of a post COVID world order. The primacy of the USD is confirmed. The credibility of the USD as a safe haven receives a thumbs up.

The number of currencies that start to buckle under continued USD strength is on the rise. At the core sits the FED policy rate reaction function that seems to have taken most OECD central banks by surprise through its resolve. The market implied policy rates point to levels between 4.50% to 5.00% over spring 2023. The policy divergence between the FED and a growing number of central banks is a reality. “The USD is our currency, but it’s your problem” quipped by John Connally as treasury secretary in 1971 comes to mind. Under Nixon he negotiated the exit out of Bretton Woods settling monetary and protectionist trade issues. At the end the USD depreciated by about 20% and tensions waned. Fast forward till today one notices that imbalances are only starting to become visible. Imbalanced that are growing on the back of diverging fiscal and monetary policy choices. Expect that the higher levels of rate and equity volatility that we are getting accustomed to will pass-over into the FX arena. Currency volatility and currency games are back. Expect G7 or G19 (ex-Russia) summits to become the places where coordination and possible accords will try to dampen the impact of policy divergences. Still a long way to go before the gentlemen in power decide to do so. In the meantime: buckle up.