It is time for us to take a look at what I have long argued is the major player in monetary policy these days which is/are exchange rates. Actually although he would not put it like that Bank of England Governor Mark Carney implicitly agreed with me on Tuesday.
“The UK economy has … had a large external imbalance and that large external imbalance as represented by a large current account deficit needed to be righted,” he said. “The exchange rate is part of that adjustment mechanism.”
I will return to the situation of the UK later but the main mover recently has Trumped (sorry) markets as we have seen the US Dollar soar. This morning Investing.com put it like this.
The dollar paused on Thursday after rising to 14-year highs against a basket of the other major currencies……..The US dollar index, which measures the greenback’s strength against a trade-weighted basket of six major currencies, was at 100.26. On Wednesday, the index hit highs of 100.60, its highest level since April 2003.
Regular readers will be aware that I have been pointing out that the US Dollar has been strong for some time. It has been rising since the dollar index dipped near 73 in April 2011 but the main move has come from just below 80 in June 2014. The Trump push has really only taken it back to where it started the year.
This poses a problem as of course we see something familiar which is the US Federal Reserve promising interest-rate rises which it was back then with the “3-5” of John Williams and now where a rise is expected by markets. We will never know if we might have been in the same place if Hillary had won.
The impact on the US economy
Most analysis concentrates on the effect elsewhere but let me open with the fact that in spite of the fact that it is still the world’s reserve currency there is an impact on the US economy from this. Just over a year ago ( November 9th) I used the numbers of Federal Reserve Vice-Chair Stanley Fischer.
The New York Fed trade model suggests that a 10 percent appreciation of the U.S. dollar is associated with a 2.6 percent drop in real export values over the year. Consequently, the net export contribution to GDP growth over the year is 0.5 percentage point lower than it would have been without the appreciation and a cumulative 0.7 percentage point lower after two years.
So there is an ongoing impact at these levels of the order of 1.5% of US economic output or GDP. If we add the impact of the currently higher bond yields we see why there are still doubts about a Federal Reserve interest-rate rise next month, although of course this is circular as these levels depend on it happening.
The rest of the world
Whilst the rest of the world in general should get a competitive advantage from a lower US Dollar it is not all one way. For example inflation will rise as so many commodities are prices in US Dollars and there is also the debt issue. From the 7th of December last year.
Dollar credit to non-banks outside the United States reached $9.8 trillion at end-Q2 2015. Borrowers resident in EMEs accounted for $3.3 trillion of this amount, or over a third. EME nationals resident outside their home countries (for instance, financing subsidiaries incorporated in offshore centres) owed a further $558 billion.
So the US Dollar is strong and yields are rising, what could go wrong? The BIS ( Bank for International Settlements) was on the case earlier this week.
A stronger 29 dollar is associated with wider CIP deviations and lower growth of cross-border bank lending denominated in dollars…….In particular, a strengthening of US dollar has adverse impacts on bank balance sheets, which, in turn, reduces banks’ risk bearing capacity.
It was also intriguing as to why the all the Ivory Towers miss this.
However, in textbooks, there are no banks.
So those places with US Dollar denominated debt have “trouble,trouble,trouble” right now and the obvious places to look would I guess be Mexico and Egypt in the way we looked at Ukraine and Russia in the past.
On the 10th of October I pointed out that the trend for the Yuan had been “down,down” in spite of its achievement of attaining reserve currency status at the IMF (International Monetary Fund).
The currency fell after the People’s Bank of China set the midpoint CNY=PBOCat 6.7008 yuan per dollar, its weakest fix since September 2010.
From the Financial Times.
China’s renminbi traded near at an eight-year low against the US dollar on Thursday, as the election of Donald Trump intensified longstanding depreciation pressure…The Chinese currency has weakened for seven of the eight trading days to Wednesday and is down 5.5 per cent in 2016 — on pace for its worst year since authorities depegged it from the dollar in 2005.
A type of stealth devaluation sees it at 6.88. Rather oddly the Wall Street Journal tells us it is not devaluing and then prints this.
The Chinese yuan has been steadily depreciating this year against a basket of 13 currencies that make up the underlying reference point for the currency.
I thought I would throw this in as having been (correctly) critical of the FT let me also say that it can also be good. From @M_C_Klein.
If I were going to hit a country for currency manipulation on day 1 it would definitely be Sweden.
Makes you think er well yes, doesn’t it?
There is no stealth devaluation here and the sound of cheering from the Bank of Japan in Tokyo at the recent fall echoes around the world. Governor Kuroda has been enjoying his sake and his favourite Karaoke song even more.
Get down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down
That of course would be the status quo if he had his way. Mind you his pleasure at an exchange rate of 109 to the US Dollar does have a fly in the ointment. After all it has happened after he did nothing as opposed to the currency rise following his “bold action” in January. I would suggest that Bank of Japan staff who want a career describe the recent phase as an example of the “masterly inaction” so beloved of the apochryphal civil servant Sir Humphrey Appleby.
I pointed out on twitter yesterday that Mario Draghi would be celebrating as the Euro dipped into the 1.06s versus the US Dollar. He needed something like that as you see the effective or trade weighted exchange rate for the Euro has risen in 2016 in spite of the 80 billion Euros a month of QE bond purchases. There is still a way to go from the 94.7 of now to the 92.7 of then. A Baldrick style cunning plan might be for the Euro to leave the European Union….Oh hang on.
As you can see there is much going on and if we compare this to a possible 0.25% interest-rate rise in the US we see again a bazooka and a pea shooter. Although of course the two factors are correlated so we can never entirely split them. But much is in play as we remind ourselves that unless there is life on Mars it is a zero-sum game.
I did say I would look at the UK which recently has been reversing some of its depreciation. It has a case for a lower currency due to its current account deficit but whilst the economic numbers are good now the problem will be the inflation of 2017 and maybe beyond. Meanwhile having checked the booming UK Retail Sales numbers let me say thank you ladies,women and girls one more time and I am on the case.
Me on Tip TV Finance