The world wants and needs US Dollars and it wants them now

In the midst if the financial market turmoil there has been a consistent theme which can be missed. Currency markets rarely get too much of a look in on the main stream media unless they can find something dramatic. But CNN Business has given it a mention.

The US dollar is rallying against virtually every other currency and it seems like nothing can stop it.

There are lots of consequences and implications here but let us start with some numbers. My home country has seen an impact as the UK Pound £ has been pushed back to US $1.20 and even the Euro which has benefited from Carry Trade reversals ( people borrowed in Euros to take advantage of negative interest-rates) has been pushed below 1.10. Even the Japanese Yen which is considered a safe haven in such times has been pushed back to 107.50. We can get more thoughts on this from The Straits Times from earlier today.

SYDNEY (REUTERS) – The Australian dollar was ravaged on Wednesday (March 18) after toppling to 17-year lows as fears of a coronavirus-induced global recession sent investors fleeing from risk assets and commodities, with panic selling even spilling over into sovereign bonds.

The New Zealand dollar was also on the ropes at US$0.5954, having shed 1.7 per cent overnight to the lowest since mid-2009.

The Aussie was pinned at US$0.6004 after sliding 2 per cent on Tuesday to US$0.5958, depths not seen since early 2003.

So there are issues ans especially in a land down under as an Aussie Dollar gets closer to the value of a Kiwi one. In fact the Aussie has been hit again today falling to US $0.5935 as I type this. No doubt it is being affected by lower commodity prices signalled in some respects by Dr. Copper falling by over 4% to US $2.20

Sadly the effective or trade-weighted index is not up to date but as of the 13th of this month the official US Federal Reserve version was at 120.7 as opposed to the 115 it began the year.

Demand for Dollars

It was only on Monday we looked at the modifications to the liquidity or FX Swaps between the world’s main central banks. Hot off the wires is this.

BoE Allots $8.210B In 7 Day USD Repo Operation ( @LiveSquawk )

This means that even in the UK we are seeing demands for US Dollars which cannot be easily got in the markets right now. Maybe whoever this is has been pushing the UK Pound £ down but we get a perspective by the fact that this facility had not been used since mid-December when the grand sum of $5 million was requested. There were larger requests back in November 2008.

I was surprised that so little notice was taken when I pointed this out yesterday.

Interesting to see the Bank of Japan supply some US $30.3 billion this morning until June 11th. Was it Japanese banks who were needing dollars?

Completing the set comes the European Central Bank or ECB.

FRANKFURT (Reuters) – The European Central Bank on Wednesday lent euro zone banks $112 billion at two auctions aimed at easing stress in the U.S. dollar funding market, part of the financial fallout of the coronavirus outbreak.

The ECB said it had allotted $75.82 billion in its new 84-day auction, introduced by major central banks last weekend in response to global demand for greenbacks, and $36.27 billion at its regular 7-day tender.

Actually it was good the ECB found the time as it is otherwise busy arguing with itself.

With regards to comments made by Governor Holzmann, the ECB states:

The Governing Council was unanimous in its analysis that in addition to the measures it decided on 12 March 2020, the ECB will continue to monitor closely the consequences for the economy of the spreading coronavirus and that the ECB stands ready to adjust all of its measures, as appropriate, should this be needed to safeguard liquidity conditions in the banking system and to ensure the smooth transmission of its monetary policy in all jurisdictions.

So we see now why the Swap Lines were reinforced and buttressed.

Oh and even the Swiss Banks joined in.

*SNB GETS $315M BIDS FOR 84-DAY DOLLAR REPO ( @GregBeglaryan )

Emerging Markets

This is far worse and let me give you a different perspective on this. During the period of the trade war we looked regularly at the state of play in the Pacific as it was being disproportionately affected.

Let me hand you over to @Trinhnomics or Trinh Nguyen.

Swap lines to EM please (also to Australia – we like Australia in Asia too as it’s APAC). “the supply of liquidity by central banks is beneficial only to those who can access it,

Her concern was over that region and EM is Emerging Markets. I enquired further.

Operationally, the bid for USD in Asia and squeeze in liquidity reflects the massive role of the USD in the global economy & finance. For example, 87% of China merchandise trade is invoiced in US. and the loss of income from export earnings will further push higher the demand of USD. To overcome the global USD squeeze, the Fed must step up its operational support via swap lines with economies such as South Korea.

That was from a piece she wrote for the Financial Times but got cut from it. On twitter she went further with a theme regular readers will find familiar

Guys, the reason why we have a dollar shortage is because we have levered!!!!!!!!!!! So when income collapses, we got major problem because we have leveraged & so debt needs servicing etc. Aniwaize, the stress u see is because we live in a world that’s too leveraged!!!

And again although I would point out that leverage can simply be a gamble rather than a hope for better times.

Don’t forget that low rates only lower interest expense, u still got principal that is high if ur debt stock is high. When u lever, u think the FUTURE IS BETTER THAN TODAY. Obvs very clearly that whoever thought there was growth is in for a surprise given the pandemic situation.

She looks at this from the perspective of the Malaysian Ringgit which has fallen to 4.37 versus the US Dollar and the Singapore Dollar which is at 1.44.

Comment

We are now seeing a phase of King Dollar or Holla Dollar and let me add some more places into the mix. We have previously looked at countries which have borrowed in US Dollars and they will be feeling the strain especially if they are commodity producers as well. This covers quite a few countries in Latin America and of course some of those have their own problems too boot. I also recall Ukraine running the US Dollar as pretty much a parallel currency.

The beat goes on.

In times of stress, capital flees emerging markets to seek safety in $USD . This crisis is no different. ( @IceCapGlobal)

which got this reply.

Investors have yanked at least US$55bn from EMs since January 21, according to the Institute of International Finance, exceeding the withdrawal in 2008. ( @alexharfouche1 )

Let me finish by reminding you that ordinarily we discuss matters around the price of something. But here as well as that we are discussing how much you can get and for some right now that people will not trade with you at all. That is why we are seeing what is effectively the world’s central bank the Federal Reserve offering US Dollars in so many different ways. It is spraying US $500 billion Repo operations around like confetti but I am reminded of the words of Glenn Frey.

The heat is on, on the street
Inside your head, on every beat
And the beat’s so loud, deep inside
The pressure’s high, just to stay alive
‘Cause the heat is on

The Investment Channel

Australia cuts interest-rates for the third time in five months

This morning has brought news that we were expecting so let me hand you over to the Reserve Bank of Australia or RBA.

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.75 per cent.

This means that the RBA has cut three times since the fifth of June. Thus those who travel in a land down under are seeing a central bank in panic mode as it has halved the official interest-rate in this period. It means that they have joined the central bankers headbangers club who rush to slash interest-rates blindly ignoring the fact that those who have already done so are singing along with Coldplay.

Oh no I see
A spider web it’s tangled up with me
And I lost my head
And thought of all the stupid things I said
Oh no what’s this
A spider web and I’m caught in the middle
So I turned to run
The thought of all the stupid things I’ve done.

If we look at the statement we get a reminder of our South China Territories theme.

The US–China trade and technology disputes are affecting international trade flows and investment as businesses scale back spending plans because of the increased uncertainty. At the same time, in most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. In China, the authorities have taken further steps to support the economy, while continuing to address risks in the financial system.

We can cut to the nub of this by looking at what the RBA also released this morning.

Preliminary estimates for September indicate that the index decreased by 2.7 per cent (on a monthly average basis) in SDR terms, after decreasing by 4.6 per cent in August (revised). The non-rural and rural subindices decreased in the month, while the base metals subindex increased. In Australian dollar terms, the index decreased by 3.5 per cent in September.

So the benefit from Australia’s enormous commodity resources has faded although it is still just above the level last year.

Over the past year, the index has increased by 1.8 per cent in SDR terms, led by higher iron ore, gold and beef & veal prices. The index has increased by 5.2 per cent in Australian dollar terms.

Aussie Dollar

The index above makes me think of this and here is a view from DailyFX.

Australian Dollar price action has remained subdued throughout most of 2019 with spot AUDUSD trading slightly above multi-year lows.

As I type this an Aussie Dollar buys 0.67 of a US Dollar which is down by 6.6% over the past year. The trade-weighted index has been in decline also having been 65.1 at the opening of 2018 as opposed to the 58.9 of this morning’s calculation.

So along with the interest-rate cuts we have seen a mild currency depreciation or devaluation. But so far President Trump has not turned his attention to Australia.

Also if we stay with DailyFX I find the statement below simply extraordinary.

 if the central bank continues to favor a firm monetary policy stance since announcing back-to-back rate cuts.

A firm monetary stance?

Back to the RBA Statement

Apparently in case you have not spotted it everybody else is doing it.

Interest rates are very low around the world and further monetary easing is widely expected, as central banks respond to the persistent downside risks to the global economy and subdued inflation.

As central bankers are pack animals ( the idea of going solo wakes them up in a cold sweat) this is very important to them.

Then we got a bit of a “hang on a bit moment” with this.

The Australian economy expanded by 1.4 per cent over the year to the June quarter, which was a weaker-than-expected outcome. A gentle turning point, however, appears to have been reached with economic growth a little higher over the first half of this year than over the second half of 2018.

Now if you believe that things are turning for the better an obvious problem is created. Having cut interest-rates twice in short order why not wait for more of the effect before acting again as the full impact is not reached for 18/24 months and we have barely made four?

Mind you if you look at the opening of the statement and the index of commodity prices you may well be wondering how that fits with this?

a brighter outlook for the resources sector should all support growth.

Indeed the next bit questions why you need three interest-rate cuts in short order as well.

Employment has continued to grow strongly and labour force participation is at a record high.

With that situation this is hardly a surprise as it is only to be expected.

Forward-looking indicators of labour demand indicate that employment growth is likely to slow from its recent fast rate.

The higher participation rate makes this hard to read and analyse.

Taken together, recent outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.

Moving to inflation the RBA seems quite happy.

Inflation pressures remain subdued and this is likely to be the case for some time yet. In both headline and underlying terms, inflation is expected to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021.

It does not seem to bother them much that if wage growth remains weak trying to boost inflation is a bad idea. Also if they look at China there is an issue brewing especially as the Swine Fever outbreak seems to be continuing to spread.

Pork prices have surged more than 70% this year in China due to swine fever, and “people are panicking.”

( Bloomberg)

House Prices

These are always in there and we start with an upbeat message.

There are further signs of a turnaround in established housing markets, especially in Sydney and Melbourne.

Yet the foundations quickly crumble.

In contrast, new dwelling activity has weakened and growth in housing credit remains low. Demand for credit by investors is subdued and credit conditions, especially for small and medium-sized businesses, remain tight.

Comment

A complete capitulation by the RBA is in progress.

It is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

They like their other central banking colleagues around the word fear for the consequences so they are getting their retaliation in early.

The Board also took account of the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes.

This is referring to the use of what is called r* or the “natural” rate of interest which of course is anything but. You see in this Ivory Tower fantasy it is r* which is cutting interest-rates and not their votes for cuts. In fact it is nothing at all to do with them really unless by some fluke it works in which case the credit is 100% theirs.

Sweet fantasy (sweet sweet)
In my fantasy
Sweet fantasy
Sweet, sweet fantasy ( Mariah Carey )

 

 

Will the 2020’s be a decade of currency devaluations?

Sometimes financial markets set the agenda for the week and as this week began they did so as the Renminbi ( Yuan) of China passed what some might call lucky number 7. The New York Times has put it like this.

The renminbi traded in mainland China on Monday morning at roughly 7.02 to the dollar, compared with about 6.88 late on Friday. A higher number represents a weaker currency. The last time China’s currency was weaker than 7 to the dollar was in 2008, as the financial crisis mounted.

In itself a 0.01 move through 7 is no more significant than any other. But that would be in a free float which is not what we have here. Also there has been a move of the order of 2% in total which is significant for an exchange rate which is both closely watched and would be more accurately described as a sort of managed free float. Anyway you do not have to take my word for it as in a happy coincidence the People’s Bank of China has been explaining its position.

China implements a managed floating exchange rate system based on market supply and demand with reference to a basket of currencies. Market supply and demand play a decisive role in the formation of exchange rate. The fluctuation of RMB exchange rate is determined by this mechanism . This is the proper meaning of the floating exchange rate system. From the perspective of the global market, as the exchange rate between currencies, exchange rate fluctuations are also the norm.

There are more holes than in a Swiss Cheese there as we observe an official denial that China has done this deliberately.

Affected by unilateralism and trade protectionism measures and the imposition of tariff increases on China, the RMB has depreciated against the US dollar today, breaking through 7 yuan, but the renminbi continues to be stable and strong against a basket of currencies. This is the market. Supply and demand and the reflection of fluctuations in the international currency market.

The PBOC clearly does not follow UK politics as otherwise it would know “strong and stable” means anything but these days! For example  the Reminbi has fallen by 1.8% versus the Japanese Yen if we stay in the Pacific and by 1.7% versus the Euro if we look wider.

Time for a poetic influence

I regularly report on the rhetoric of central bankers but I am not sure I have seen anything like this before.

It should be noted that the RMB exchange rate is “ breaking 7” . This “7” is not the age. It will not come back in the past, nor is it a dam. Once it is broken, it will bleed for thousands of miles. “7” is more like the water level of the reservoir, and the water is abundant. The period is higher, and it will fall down when it comes to the dry season. It is normal to rise and fall.

Perhaps the online translator does not help much here but there is a lot more going on than for example the English translation of the Japanese government always being “bold action” for the Yen.

Up is the new down

If your currency is falling then the obvious “Newspeak” response is to suggest it is rising.

In the past 20 years, the nominal effective exchange rate and the real effective exchange rate of the RMB calculated by the Bank for International Settlements have appreciated by about 30% , and the exchange rate of the RMB against the US dollar has appreciated by 20% . It is the strongest currency among the major international currencies. Since the beginning of this year, the renminbi has remained in a stable position in the international monetary system. The renminbi has strengthened against a basket of currencies, and the CFETS renminbi exchange rate index has appreciated by 0.3%

However if you are telling people this is due to the market it might be best to avoid phrases like “control toolbox,”

In the process of dealing with exchange rate fluctuations in recent years, the People’s Bank of China has accumulated rich experience and policy tools, and will continue to innovate and enrich the control toolbox.

So let me finish this section by pointing out that the PBOC has “allowed” the Reminbi to go through 7 this morning in response to something we noted on Friday.

Trade talks are continuing, and…..during the talks the U.S. will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25%…

As the Frenchman puts it in the Matrix series of films.

action and reaction, cause and effect.

Bond Markets

One immediate impact of this has been that bond markets have surged again and we are reminded of my topic on Friday. The totem pole for this has been the bond or bund market of Germany where we see two clear developments. Another record high as the ten-year yield falls to -0.52% and as I type this the whole curve has a negative yield. Over whatever time span you choose Germany is being paid to borrow.

Japan

I do not envy the person who had the job of explaining market developments to Governor Kuroda at the Bank of Japan daily meeting. Firstly the Yen has surged into the 105s versus the US Dollar which is exactly the reverse of the Abenomics strategy of Japan. Then there was the 366 point fall in the Nikkei 225 index which is not so welcome when you own 5% of the shares on the Tokyo Stock Exchange. At least the trading desk will have been spared the job as they will have been busy buying the 70.5 billion Yen’s worth of equities that are typically bought on down days like this. This is neatly rounded off by the Japanese Government Bond market not rallying anything like as much as elsewhere due to the “yield curve control” policy backfiring and providing a clean sweep.

Oh and the day of woe was rounded off by the South Korean’s buying much fewer Japanese cars.

Switzerland

Regular readers will recall the period that I labelled the Yen and the Swiss Franc the “currency twins”. Well they are back just like Arnie and in fact with a 2.2% rally against the Renminbi it is the Swiss Franc which is the powerhouse today. It has rallied against pretty much everything as we remind ourselves of the last policy statement of the Swiss National Bank.

The situation on the foreign exchange market continues to be fragile. The negative interest rate and the SNB’s willingness to intervene in the foreign exchange market as necessary remain essential in order to keep the
attractiveness of Swiss franc investments low and thus ease pressure on the currency.

Well they were right about “fragile”. Do not be surprised if we see the SNB intervening again which will be further bullish for overseas bond and equity markets as that is where they invest much of the money.

Mind you equity markets are falling now meaning this from last week is already out of date.

SNB‘s pile of U.S. shares hits a record $93 billion on buoyant markets ( Bloomberg)

The Ashes

As I hope that England’s sadly rickety batting order can resist the pressure from a land down under today I have been mulling something else. Both countries have weak currencies at the moment and are perhaps singing along with Level 42.

The Chinese way
Who knows what they know
The Chinese legend grows

I could never lie
For honour I would lie
Following the Chinese way

 

Comment

Just like in the 1920’s will the 2020’s open with some competitive devaluations?

President Trump seems to quite like the idea if his tweets are any guide. In the Euro area we see a central bank that seems set to follow policies which in theoretical terms at least should weaken the Euro although the ECB is swimming against the trade surplus. I have covered the Swiss and the Japanese. So let me leave you with two final thoughts.

In the confused melee has the UK stolen something of a march?

Is there a major economy who wants a stronger currency?

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What has the Yen flash rally of 2019 taught us?

Yesterday we took a look at the low-level of bond yields for this stage in the cycle and the US Treasury Note yield has fallen further since to 2.63%. Also I note that the 0.17% ten-year German bond yield is being described as being in interest-rate cut territory for Mario Draghi and the ECB. That raises a wry smile after all the media analysis of a rise. But it is a sign of something not being quite right in the financial system and it was joined last night by something else. It started relatively simply as people used “Holla Dolla” to describe US Dollar strength ( the opposite of how we entered 2018 if you recall) and I replied that there also seemed to be a “yen for Yen” too. So much so that I got ahead of the game.

What I was reflecting on at this point was the way that the Yen had strengthened since mid December from just under 114 to the US Dollar to the levels referred to in the tweet. For newer readers that matters on two counts. Firstly Japanese economic policy called Abenomics is geared towards driving the value of the Yen lower and an enormous amount of effort has been put into this, so a rally is domestically awkward. In a wider sweep it is also a sign of people looking for a safe haven – or more realistically foreign exchange traders front-running any perceived need for Mrs.Watanabe to repatriate her enormous investments/savings abroad  –  and usually accompanies falling equity markets.

The Flash Rally

I was much more on the ball than I realised as late last night this happened. From Reuters.

The Japanese yen soared in early Asian trading on Thursday as the break of key technical levels triggered massive stop-loss sales of the U.S. and Australian dollars in very thin markets. The dollar collapsed to as low as 105.25 yen on Reuters dealing JPY=D3, a drop of 3.2 percent from the opening 108.76 and the lowest reading since March 2018. It was last trading around 107.50 yen………..With risk aversion high, the safe-haven yen was propelled through major technical levels and triggered massive stop-loss flows from investors who have been short of the yen for months.

As you can see there was quite a surge in the Yen, or if you prefer a flash rally. If a big trade was happening which I will discuss later it was a clear case of bad timing as markets are thin at that time of day especially when Japan is in the middle of several bank holidays. But as it is in so many respects a control freak where was the Bank of Japan? I have reported many times on what it and the Japanese Ministry of Finance call “bold action” in this area but they appeared to be asleep at the wheel in this instance. Such a move was a clear case for the use of foreign exchange reserves due to the size and speed of the move,

There were also large moves against other currencies.

The Australian dollar tumbled to as low as 72.26 yen AUDJPY=D3 on Reuters dealing, a level not seen since late 2011, having started around 75.21. It was last changing hands at 73.72 yen.

The Aussie in turn sank against the U.S. dollar to as far as $0.6715 AUD=D3, the lowest since March 2009, having started around $0.6984. It was last trading at $0.6888.

Other currencies smashed against the yen included the euro, sterling and the Turkish lira.

There had been pressure on the Aussie Dollar and it broke lower against various currencies and we can bring in two routes to the likely cause. Yesterday we noted the latest manufacturing survey from China signalling more slowing and hence less demand for Australian resources which was followed by this. From CNBC.

 Apple lowered its Q1 guidance in a letter to investors from CEO Tim Cook Wednesday.

Apple stock was halted in after-hours trading just prior to the announcement, and shares were down about 7 percent when trading resumed 20 minutes later.

This particular letter from America was not as welcome as the message Tim Cook sent only a day before.

Wishing you a New Year full of moments that enrich your life and lift up those around you. “What counts is not the mere fact that we have lived. It is what difference we have made to the lives of others that will determine the significance of the life we lead.” — Nelson Mandela

So the economic slow down took a bite out of the Apple and eyes turned to resources demand and if the following is true we have another problem for the Bank of Japan.

“One theory is that may be Japanese retail FX players are forcing out of AUDJPY which is creating a liquidity vacuum,” he added. “This is a market dislocation rather than a fundamental event.”

Sorry but it is a fundamental event as Japanese retail investors are in Australian investments because they can get at least some yield after years and indeed decades on no yield in Japan. This is a direct consequence of Bank of Japan policy as was the move in the Turkish Lira which is explained by Yoshiko Matsuzaki.

This China news hit the EM ccys including Turkish lira where Mrs Watanabe are heavily long against Yen. I bet their stops were triggered in the thin market. Imagine to have TRYyen stops in this market.

So there you have it a development we have seen before or a reversal of a carry trade leading the Japanese Yen to soar. Even worse one caused by the policy response to the last carry trade blow-up! Or fixing this particular hole was delegated to the Beatles.

And it really doesn’t matter if I’m wrong
I’m right

Bank of England

It too had a poor night as whilst it is not a carry trade currency with Bank Rate a mere 0.75% the UK Pound £ took quite a knock against the Yen to around 132. Having done this we might reasonably wonder under what grounds the Bank of England would use the currency reserves it has gone to so much trouble to boost? From December 11th.

Actually the Bank of England has been building up its foreign exchange reserves in the credit crunch era and as of the end of October they amounted to US $115.8 billion as opposed as opposed to dips towards US $35 billion in 2009. So as the UK Pound £ has fallen we see that our own central bank has been on the other side of the ledger with a particular acceleration in 2015. I will leave readers to their own thoughts as to whether that has been sensible management or has weighed on the UK Pound £ or of course both?!

To my mind last nights move was certainly an undue fluctuation.

The EEA was established in 1932 to provide a fund which could be used for “checking undue fluctuations in the exchange value of sterling”.

It is an off world where extraordinary purchases of government bonds ( £435 billion) are accompanied by an apparent terror of foreign exchange intervention.

Comment

I have gone through this in detail because these sort of short-term explosive moves have a habit of being described as something to brush off when often they signal something significant. So let is go through some lessons.

  1. A consequence of negative interest-rates is that the Japanese investors have undertaken their own carry trade.
  2. The financial system is creaking partly because of point 1 and the ongoing economic slow down is not helping.
  3. Contrary to some reports the Euro was relatively stable and something of a safe haven as it behaved to some extent like a German currency might have. There is a lesson for economic theory about negative interest-rates especially when driven by a strong currency. Poor old economics 101 never seems to catch a break.
  4. All the “improvements” to the financial system seem if anything to have made things worse rather than better.
  5. Fast moves seem to send central banks into a panic meaning that they do not apply their own rules.

We cannot rule out that this was deliberate and please note the Yen low versus the US Dollar was 104.9 as you read the tweet below.

Japanese exporters had bought a lot of usd/jpy puts at year end with 105 KOs so now they are really screwed … ( @fxmacro )

Me on The Investing Channel

 

 

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.

Australia

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..

Comment

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