Monetary policy seems to have been delegated to the currency markets

Last night was simply superb at what might be called the battle of Stamford Bridge where at times an exciting football match broke out leading to a 2-2 scoreline which meant that previously lowly Leicester City are champions of the premier league. Well done to them and their fans and it was a shame that the sonic booms of the RAF Typhoons in the air were over another town beginning with a L namely Leeds. It makes me think how bad we are as humans at comparing events with perceived ultra low probability. From Hilary Evans.

Betting odds in August. Leicester to win Premier League 5000-1 Elvis to be found alive working in a chip shop in Macclesfield 2000-1

Oh and the 2000-1 bet was probably influenced by fans of this song from Kirsty MacColl.

There’s a guy works down the chip shop swears he’s elvis

However there is another event or two be precise two events taking place now that according to economic theory should not be happening and we find them in the currency markets.

The currency depreciators in fact appreciate

There has been a change in 2016 and what it represents is that the two main central banks which are trying to lower their currency have in fact seem them rally. This morning there were two clear notable sights in markets as the Euro pushed towards 1.16 versus the US Dollar and the Japanese Yen strengthened though 106 to 105.6. This will have Mario Draghi of the ECB spluttering on his morning espresso or cappuccino and perhaps ordering an extra glass of chianti with his lunch. Actually as Mario notes that around a third of the new bank rescue fund for Italy has already been used he may raise his chianti order to the whole bottle!

Meanwhile in Japan Governor Kuroda will not be in a mood to celebrate the 3 day Golden Week break and of course if anyone has had an anti-Midas touch it is him. As in essence the policy of Abenomics he was appointed to enforce involved a lower Yen there is an obvious problem with it rising. In fact even hard-core supporters must be struggling to name an arrow of Abenomics that is even partially working right now and I wait to see how the many in the media deal with this reality.

Let us analyse the scale of what has taken place here. It reminds me of quite a few instances in UK economic policy where the UK Pound £ has done exactly the reverse of both plans and hopes for it.

The Euro

As a backdrop we need to recall that the ECB has cut its deposit and current account interest-rate to -0.4% and raised its monthly amount of QE (Quantitative Easing) bond purchases to 80 billion Euros a month, or just shy of a trillion a year. What has it got for that?

If we look at the chart against the US Dollar we see that the falls were in 2014 and early 2015 and that over the past year the Euro is now up by over 3%. This fits with my theory that the main currency falls from a policy of QE happen in advance of it as expectations build and that the reality of it sees a situation where the boat often has already sailed. If we look at the effective or trade weighted exchange rate it fell from 104 to 89 in early April 2015 but has since rallied to 95.

A couple of years ago we did get a “Draghi Rule” for measuring the impact of all this.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

So the same inflation which he is trying to raise will in fact be reduced by around 0.3% by the Euro strength.

Oh and the ECB is also pot-shotting at the behaviour of other central banks. Whilst I welcome that it is catching up a little with my “early-wire” theme it seems to have forgotten that it used to give private-briefings to hedge funds.

Eleven out of these 21 announcements exhibit some pre-announcement price drift in the “correct” direction, i.e., in the direction of the price change consistent with the announcement surprise. For seven of these announcements the drift is substantial.


The Yen

Whilst the Yen has been something of a currency twin with the Euro it has been in the worst place as you see it has rallied against it as well. Cue more pictures of Governor Kuroda with his face in his hands. Back in late 2014 it just failed to make 150 Yen per Euro compared to the 122.5 now. Thus the Yen has surged and with apologies for it being tardy with updates but the trade weighted Yen courtesy of the Bank of England has risen from 127 to 141 over the past year.

Sadly the Bank of Japan has not published any form of the Draghi Rule as I suppose it is anti their culture. But of the rules we do have I think it applies the most so we see that inflation will be some 0.6% lower due to the appreciation over the past year. The calculation assumes we remain here as do the ones above and they give plenty of food for thought.

Another way of looking at the situation is that Abenomics has jumped into the TARDIS of Doctor Who and travelled back to November 2013.

The UK

There has been a reversal here too as the falls of early 2016 have been followed by a recovery to US $1.47. The trade weighted index has recouped about half of its earlier losses with in essence the 2016 falls being against the two currencies discussed above. Of course so much is in flux but with UK manufacturing weak and the Pound stronger we could easily see someone at the Bank of England vote for a Bank Rate cut. At which point we see yet another reversal for Forward Guidance.


If we look to the land “down under” we see that the Reserve Bank of Australia cut interest-rates by 0.25% to 1.75% this morning. This did seem to be aimed at one particular target.

though an appreciating exchange rate could complicate this.

As the “Aussie” has fallen I guess they will be happy. Those familiar with the UK experience will feel a chill down their spines as the note the use of “rebalancing” in a situation proving central banks all borrow from each other.

The US Dollar

Here we get the most awkward situation for economic theory as it is raising interest-rates and therefore should have a strong dollar. Reality by contrast fits much more nicely with my anticipation and expectation theme especially as the Federal Reserve seems to have forgotten and redacted its own Forward Guidance. The Dollar Index had a couple of goes at passing 100 but now is at 92. According to US Federal Reserve vice-Chair Fischer that will raise GDP by between 0.8% and 1.2%

So we have the country which was tightening monetary policy via interest-rate rises ( although in reality we do not need the plural as only one has happened so far) and a higher currency is now seeing easing via currency falls. Oh what a tangled web and all that..


I have left one elephant in the room until now which is the supposed existence of a Shanghai Accord. Some elements of it do seem to be in play but I am cautious about conspiracy theories especially in currency markets. Maybe that is because I am British as the UK Pound £ has spent so much time at the “wrong” level meaning that we have not been able to control it! Maybe just the existence of the theory has contributed to what we have seen especially as we note that the moves were already in play well before the accord.

But as the moment most currencies seem to be getting what their central banks do not want! Still according to the Rolling Stones that may not be all bad.

You can’t always get what you want
But if you try sometime you find
You get what you need





21 thoughts on “Monetary policy seems to have been delegated to the currency markets

  1. The rise of the Euro and the Yen is very contrary to economic theory but what I do not understand is why this is happening? What do the currency markets see that I do not?

    I have just returned from Vienna and whilst the Austrian economy looks to be healthy some of the figures I saw would indicate they are massively exposed to loans to countries to the east of them. They must live in fear of any slowdown there. Banks again!

    • I think that’s because a lot of economic theory playbooks were written by people with little understanding of the real world,whose models are based upon the rationale of ivory tower dwellers not those who inhabit the markets they rule over.

    • Hi Pavlaki

      Just a couple of thoughts for you on Austria which do interrelate. Firstly they were major players in the retail side of the carry trade ie mortgages and business loans in Euro’s and Swiss Francs in central and eastern Europe. Also the Heta bad bank sage rumbles on….

  2. You would have thought that when something happens which is contrary to your expectations that there would be a pause for thought: are we right about this? Obviously central banks live on another planet where, if the “unexpected” happens, this is the fault of the World rather than their models. As Einstein once said: Insanity: doing the same thing over and over again and expecting different results.

    It gets clearer by the the day that we have people in charge who have little idea what they are doing and whose ultimate aim is to preserve an edifice of debt and manipulation that has manifestly been wholly dysfunctional. I believe that the system is now unreformable and that we will have to have a catastophy as a necessary condition for change. Whether such a change will be to anything more sensible remains to be seen but I cannot see the present system carrying on in this vein for much longer. The classic diversion in this sort of situation is war but we must all hope that this does not come about.

    With respect to the Shanghai Accord it seems to me that this is yet another version of central bank hubris in which they have created a monster which they then think they can control, not realising that the monster may have ideas of its own.

    • ‘You would have thought that when something happens which is contrary to your expectations that there would be a pause for thought: are we right about this? ‘
      Quite right Bob.Wish I’d read your reply before I posted a reply to Pavlaki.

    • With respect, BobJ, I’d like to point out that, because the outcome of their actions clashes with their stated aims, it does not necessarily follow that those outcomes are contrary to their expections.
      Or put more simply, they are lying bastards.

  3. Great column, Shaun, as per usual.
    The Canadian loonie has been up recently too, and could go higher, as Michael Babad writes in the Globe & Mail today:
    Imagine having the cost of a cappuccino in a Ritz-Carlton Hotel in New York City as your yardstick for what your own currency is worth against the US greenback is worth. I’d love to have the lifestyle of a Globe correspondent!

    • Hi Andrew and thanks

      I take your point as most people might think of a bottle of Coca-Cola or follow the Big Mac index that The Economist uses rather than a US $10 Cappucino. I stopped off at a nice place today and got charged the equivalent of US $3.80 so he is living a much higher life! Or at least a more expensive one….On those grounds you might like to avoid the weekend How To Spend It Section of the FT which delights in high value consumerism.

      You are nearing what the Big Mac index considers fair value if we adjust the January numbers…..

  4. Shaun,as a long time Leicester resident,I can tell you the feelgood factor is everywhere.

    As a sometimes poster on here,they’ve given me hope that one day,someone will be able to successfully challenge the societal dominance of the big banks and the political class in London that seems all too ready to swap parliamentary seats for Board seats.

    Watching Man Utd/Chelsea/Man City,with all that spend struggle to beat a team that has the budget of just one of their strikers is pure class.Whilst,I’m delighted it’s Leicester,I’m sure many of your posters would have welcomed any small team upsetting the big boys.

    • Congratulations , my team Norwich are where
      you were a year ago I can dream that we might
      survive and will be cheering them on against
      Man U in a few days.

      • I felt for Norwich when they lost 1-0 against us.But that was really the moment I began to believe it could happen.The great title winning teams of the past had that habit of getting one nil wins out of games where they should have lost or drawn and in many ways,that run we had of 5 out of 6 1-0 wins was the turning point of the campaign.

        For what it’s worth I’ll be cheering for them against Man Utd.It’ll make me smile to watch them miss out on the Champions League if West ham can get the results together.

    • In another analogy with economics, Leicester’s triumph was achieved contrary to the accepted, home-spun, “wisdom”, which proved to be charlatanism after all.

      • They played contrary to previous Championship winning norms.Shocking pass completion rates,lowest possession stats in the league etc etc.

        According to the playbooks of the ivory tower brigade,we should have been smashed.

    • Hi therrawbuzzin

      You have a point there but as they presumably have the markets at least to some extent (rigged) where they want them to be and it is not working well…….when will it? With even the RBA cutting again it feels somewhat endless.

  5. Hi Shaun brilliant piece again today.
    The currency supply/debt these are one in the same of major western economies have been increasing exponentially for several decades.
    In my naivety I always thought that the more plentiful something was the less it was worth,yet official figures tell us we have deflation.
    I also thought that if you were technically insolvent then to borrow money you had to pay a large yield as you would be high risk but bond yields are at 300 year lows.
    There are only two possible reasons for this the laws of supply and demand are wrong and you can create money/debt to infinity and therefore there is no risk or the markets are rigged but at some point there will be an economic meltdown .

    • Hi Private Fraser and thanks

      One of the lessons of the credit crunch is that it is teaching us new things in the sphere of financial economics. For example narrow money can be supplied but via velocity changes broader money can shrink at the same time as it is more of a demand creation. Awkward and not well understood by those in power. They could of course ( Venezuela currently excepted) literally print and print but they are of course against higher denomination notes! Oh what a tangled web…

      As to bond yields they are simply extraordinary and it is a reflection of not only the QE so far but the expectation of QE to infinity I think. But remember consequences do not have to be and usually are not immediate and quite often ( there is a Leicester City link) can be found to be in an area considered impossible.

  6. Hi Shaun,

    Excellent analysis as usual.

    With a slowing global economy and outlook where we are at the end of an economic cycle, how long will it be before the BOE and the Fed are wheeling out Buzz Lightyear for new rounds of QE to infinity and beyond and interest rate trending towards minus infinity? All to make things even worse, but in their eyes, they will talk up that the patient looks a bit more ‘rosy’ cheeked.

    I don’t think the Central Banks or politicians know how to get back from where they have taken us economically, so it will just be more voodoo magic, spinning plates, smoke and mirrors to keep everything going for a bit longer.

    In the 1950’s 1 in 3 economies defaulted. With ever rising debts to me it looks like this is where many countries are heading.

    • Hi Rods and thanks

      These days even defaults are not what they were! I mean Greece continues to be able to borrow from the Institutions in spite of the 2012 PSI default. Although of course the price is to be found elsewhere other than in the cost of borrowing as the continuing depression demonstrates. Meanwhile as I pointed out today the Italian bank fund seems to be shrinking fast. I thought they might at least make the summer.

      On the one hand the Italian banks parlous state does not matter as Mario will ride to the rescue, on the other it matters a lot as they will not support the economy until there is reform.

      • Mario is dependent on the Bundesbank’s continued membership of the euro. Germexit is unthinkable with Merkel in power, and I couldn’t find any German election 2017 betting odds. After Leicester came in at 5000 to 1, 10 euro on an outsider could be entertaining.

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