What are the consequences of a weak US Dollar?

So far 2018 has seen an acceleration of a trend we saw last year which is a fall in the value of the US Dollar. The latest push was provided by the US Treasury Secretary only yesterday at Davos. From Bloomberg.

“Obviously a weaker dollar is good for us as it relates to trade and opportunities,” Mnuchin told reporters in Davos. The currency’s short term value is “not a concern of ours at all,” he said.

“Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency,” he said.

The way it then fell it is probably for best its value is not a concern as the rhetoric was both plain and transparent.

A day before Trump’s scheduled arrival in the Swiss ski resort of Davos for the World Economic Forum’s annual meeting, Treasury Secretary Steven Mnuchin endorsed the dollar’s decline as a benefit to the American economy and Commerce Secretary Wilbur Ross said the U.S. would fight harder to protect its exporters.

The response to the words is a pretty eloquent explanation of why policy makers have a general rule that you do not comment on the level of the exchange rate. Not only might you get something you do not want there is also the issue of being careful what you wish for! Sadly the Rolling Stones were not on the case here.

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

However you spin it we are in a phase where the US government is encouraging a weaker dollar as part of the America First strategy. It has already produced an echo of the autumn of 2010 if this from the Managing Director of the IMF is any guide.

 “It’s not time to have any kind of currency war,” Lagarde said in an interview with Bloomberg Television.

Criticising someone for rhetoric by upping the rhetoric may not be too bright. Also there are more than a few examples of countries trying to win the race to the bottom around the world.

What does a lower US Dollar do?

Back in November 2015 Stanley Fischer gave us the thoughts of the US Federal Reserve.

To gauge the quantitative effects on exports, the thick blue line in figure 2 shows the response of U.S. real exports to a 10 percent dollar appreciation that is derived from a large econometric model of U.S. trade maintained by the Federal Reserve Board staff. Real exports fall about 3 percent after a year and more than 7 percent after three years.The gradual response of exports reflects that it takes some time for households and firms in foreign countries to substitute away from the now more expensive U.S.-made goods.

Also imports are affected.

The low exchange rate pass-through helps account for the more modest estimated response of U.S. real imports to a 10 percent exchange rate appreciation shown by the thin red line in figure 2, which indicates that real imports rise only about 3-3/4 percent after three years.

This means that the overall economy is affected as shown below.

The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years. Moreover, the effects materialize quite gradually, with over half of the adverse effects on GDP occurring at a horizon of more than a year.

Okay we need to flip all of that around of course because we are discussing a lower US Dollar this time around. Net exports will be boosted which will raise economic output or GDP over time.

How much?

If we look at the US Dollar Index we see at 89.1 it has already fallen by more than 3% this year. The recent peak was at just over 103 as 2016 ended so we have seen a fall of a bit under 14%. The official US Federal Reserve effective exchange rate has fallen from 128.9 in late December 2016 to 116.8 at the beginning of this week so 116 now say. Conveniently that gives us a fall of the order of 10%.

So if we look up to the preceding analysis we see that via higher exports and reduced imports US GDP will be 1.5% higher in three years time than otherwise.

What about inflation?

There is a lower impact on the US because of the role of the dollar as the reserve currency and in particular as the currency used for pricing the majority of commodities.

While the Board staff uses a range of models to gauge the effect of shocks, the model employed in figure 4–as well as other models used by staff–suggests that the dollar’s large appreciation will probably depress core PCE inflation between 1/4 and 1/2 percentage point this year through this import price channel.

You may note that Stanley Fischer continues the central banking obsession with core inflation measures when major effects will come from food and energy. It would be entertaining when they sit down to luncheon to say that we are having a core day so there isn’t any! Have you ever tried eating an i-pad?

So inflation may be around 0.5% higher.

What about everybody else?

The essential problem with reducing the value of your currency to boost your economy via exports is that overall it is a zero-sum game. As you win somebody else loses.  So the gains are taken from somebody else as no doubt minds in Beijing, Tokyo and Frankfurt are thinking right now. Of course pinning an actual accusation on the United States is not easy because of its persistent trade deficits.

Furthermore the exchange-rate appreciation seen elsewhere will not be welcomed by the ECB ( European Central Bank) and particularly the Bank of Japan. The latter is pursuing an explicit Yen depreciation policy to try to generate some inflation whereas what it has instead seen is a rise towards 109 versus the US Dollar. Of course workers and consumers will have reason to thank the lower dollar as lower inflation will boost their spending power.

Later today we will see how Mario Draghi handles this at the ECB policy meeting press conference. He finds himself pursuing negative interest-rates and still substantial if tapering QE and a stronger currency. It is hard for him to be too critical of the US though when even Christine Lagarde is saying this.

LAGARDE: GERMANY’S 8% CURRENT ACCOUNT SURPLUS IS EXCESSIVE ( @lemasabacthani)

Of course that takes us back to a past competitive depreciation which Germany arranged via its membership of the Euro.

Comment

There is a fair bit to consider here. As it stands it looks as though the US economy will benefit over the next 3 years (convenient for the political timetable) by around 1.5% of GDP at the cost of higher inflation of 0.5%. There are two main problems with this type of analysis of which the first is simply the gap between theory and reality. The smooth mathematical curves of econometrics are replaced in practice by businesses and consumers ignoring moves for as long as they can and then responding but by how much and when? So we see a succession of jump moves. The other issue is that exchange-rates are usually on the move and can change in an instant unlike economies leaving us wondering which exchange-rate they are responding too?

Next we have the awkward issue of a country raising interest-rates and seeing a currency depreciation. Theory predicts the reverse. I have a couple of thoughts on this and the first is about timing. In my opinion exchange-rates these days move on expectations of an event so they have already happened before it does. So the current phase of interest-rate rises was reflected in the US Dollar rise from the summer of 2014 to the spring of 2015. That works because if anything we have seen fewer rate rises than expected back then and the bond market has fallen less. As to the Federal Reserve well with the US Dollar here and inflation with a little upwards pressure it will therefore find a scenario which makes it easy for it to keep nudging interest-rates higher.

Meanwhile there are other factors which are hard to quantify but seem to happen. For example a lower dollar coming with higher commodity prices. Hard to explain and of course there are other factors in play, But it seems to have happened again.

Me on Core Finance TV

http://www.corelondon.tv/will-pound-go-next-vs-us-dollar/

 

 

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What is going on at the Bank of Japan?

It is time to take another step on our journey that Graham Parker and the Rumour would have described as discovering Japan as quite a bit is currently going on. On Tuesday eyes turned to the Bank of Japan as it did this according to Marketwatch.

The central bank cut its purchases of Japanese government bonds, known as JGBs, expiring within 10-25 years and those maturing in 25-40 years by ¥10 billion ($88.8 million) each.

It created something of a stir and rippled around financial markets. There were two pretty clear impacts and the first as you might expect was a stronger Yen which has become one of the themes of this week. An opening level of above 113 to the US Dollar has been replaced by just above 111 and any dip in the 110s will give a sour taste to the Friday night glass of sake for Governor Kuroda.

If we look back to this time last year we see that the Yen is stronger on that measure as back then it was above 114 versus the US Dollar. This may seem pretty poor value in return for this.

The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen.

Even in these inflated times for assets that is a lot of money and the Bank of Japan is not getting a lot of bang for its buck anymore as we have discussed. It would be particularly awkward if after not getting much progress for the extra (Q)QE any reduction or tapering took it back to where it began. The impact of Quantitative Easing on currencies is something we regularly look at as the impact has become patchy at best and this week has seen us start to wonder about what happens should central banks look to move away from centre stage. That would be a big deal in Japan as a weaker currency is one of the main arrows in the Abenomics quiver. As ever we cannot look at anything in isolation as the US Dollar is in a weaker phase as let me pick this from the Donald as a possible factor partly due to its proximity to me.

Reason I canceled my trip to London is that I am not a big fan of the Obama Administration having sold perhaps the best located and finest embassy in London for “peanuts,” only to build a new one in an off location for 1.2 billion dollars. Bad deal. Wanted me to cut ribbon-NO!

Mind you that is a lot better than what he called certain countries! If nothing else this was to my recollection also planned before the Obama administration.

Bond Markets

You will not be surprised to learn that the price of Japanese Government Bonds fell and yields rose, after all the biggest buyer had slightly emptier pockets. However in spite of some media reports the change here was not large as 0.06% for the ten-year went initially to 0.09% and has now settled at 0.07%. Up to the 7 year maturity remains at negative yields and even the 40 year does not quite yield 1%. If we look at that picture we see how much of a gift that the “independent” Bank of Japan has given the government of Shinzo Abe. It runs a loose fiscal policy where it is borrowing around 20 trillion year a year and has a debt of 1276 trillion Yen as of last September which is around 232% of GDP or Gross Domestic Product. So each year QQE saves the Japanese government a lot of money and allows it to keep its fiscal stimulus. We do not get much analysis of this in the media probably because the Japanese media is well Japanese as we mull the consequences of the owning the Financial Times.

A stronger effect was found in international bond markets which were spooked much more than the domestic one. US government bond prices fell and the 10-year yield went above 2.5% and got some questioning if we were now in a bond bear market? After around three decades of a bull market including of course these days trillions of negative yielding bonds around the globe care and an especially strong signal is needed for that. Maybe we will learn a little more if the US 2-year yield goes above 2% as it is currently threatening to do. But in a world where Italian 10-year bonds yield only 2% there is quite a way to go for a proper bond bear market.

The real economy

If we look at the lost decade(s) era then Japan is experiencing a relatively good phase right now. From The Japan Times.

The economy grew an annualized real 2.5 percent in the July-September period, revised up from preliminary data and marking seven straight quarters of growth — the longest stretch on record —.

Someone got a bit excited with history there I think as there was a time before what we now call the lost decade. However for those who call this success for Abenomics there are some things to consider such as these.

Exports grew 1.5 percent from the previous quarter amid solid overseas demand as the global economy gains traction.

Japan is benefiting from a better world economic situation but like so often in the era of the lost decades it is not generating much from within.

But private consumption, a key factor accounting for nearly 60 percent of GDP, continued to be sluggish with a 0.5 percent decline from the previous quarter as spending on automobiles and mobile phones fell.

Let us mark the fact that we are seeing another country where car demand is falling and move to what is the key economic metric for Japan.

Workers will see a 1 percent increase in their total earnings next year, the most since 1997, as rising profits and the tightest labor market in decades add upward pressure on pay, a Bloomberg survey shows.

Actually what we are not told is that compared to so many Bloomberg reports this is a downgrade as in its world wages have been on the edge of a surge for 3-4 years now. But reality according to the Japan Times is very different as we note the size of the increase it is apparently lauding.

In a sign that worker could receive better pay, a separate survey on the average winter bonus at major companies this year showed a slight increase — 0.01 percent — from a year earlier to ¥880,793, up for the fifth consecutive year.

Comment

There are quite a few things to laud Japan for as we note its ultra low unemployment rate at 2.7% and the way it takes care of its elderly in particular. At the moment the economic wheels are being oiled by a positive world economic situation which of course helps an exporting nation. That poses a question for those crediting Abenomics for the improvement as we note the more recent surveys are not as positive and the rises in commodity and oil prices and the likely effect on a nation with limited natural resources.

But more deeply this weeks market moves are tactically perhaps just a response to the way that “Yield Curve Control” works in practice which currently requires fewer bond purchases. But strategically the Bank of Japan is left with this.

 

That tweet misses out the QQE for Japan and QE for the latter two but we return yet again to monetary policy being pro cyclical and in the case of Japan fiscal policy as well. What could go wrong in a country where demographics are a ticking economic time bomb?

 

What makes a currency a safe haven these days?

The subject of safe havens is something that comes to mind as one considers the situation concerning North Korea. An unhinged leader combined with nuclear weapons and intercontinental ballistic missile technology does not make for a stable mix and of course there is Kim Jong-Un to consider as well. Mind you Twitter took the news of a possible Korean H-Bomb very calmly yesterday as it was soon replaced in the headlines by Wayne Rooney’s difficulties and today events are led by a headline which could refer to North Korea but fortunately McStrike is in fact the first strike at MacDonald’s in the UK.

So let us consider an environment where risk is higher and maybe a lot higher. This poses an early issue as my time in derivative and particularly options markets taught me that we as humans are very bad at quantifying things to which we give a low probability. We are even worse when it is something we do not want to happen. Establishments magnify this issue as I recall the excellent work of the Nobel prize-winning physicist Richard Feynman on the NASA Challenger space shuttle disaster. He was part of the enquiry and was officially told that the odds were millions to one whereas when he interviewed individual engineers they told him that individual parts had a one in five hundred chance of failure. It turned out that the disaster was not a surprise as the surprise was that it had not happened before.

What does risk-off do now?

The Japanese Yen

Each time the rhetoric or a North Korean missile rises the Japanese Yen follows it. This felt especially odd when one of the missiles overflew Japan and tripped civil defence alarms as well as no doubt having the self-defence force scrambling. Also the rally to 109.60 this morning against the US Dollar will have steam coming out of the ears of the Bank of Japan on two counts. Firstly because a lower value for the Yen is part of Abenomics and secondly it will send equity markets lower ( 190 points on the Nikkei 225 index).Still the Bank of Japan will be able to occupy itself by buying yet more equities.

If we look deeper into Yen strength in risky times I note this from the IMF in November 2013.

since the mid-1990s, there have been 12 episodes where the yen has appreciated in nominal effective terms by 6 percent or more within one quarter and these coincided often with events outside Japan

Why might this be?

Safe haven currencies tend to have low interest rates, a strong net foreign asset position, and deep and liquid financial markets. Japan meets all these criteria

The first point if we modify low to lower to bring it up to date gives us food for thought on what determines interest-rates. We are usually told domestic considerations but there is a correlation between strong trade positions and negative interest-rates for example. As to the foreign asset position then unlike its public-sector which has lots of debt Japan is in fact the largest creditor. From Reuters.

Japan’s net external assets rose to their second-highest amount on record at the end of fiscal 2016, driven by rising mergers and acquisitions overseas by firms and portfolio investment, the Finance Ministry said Friday.
The net value of assets held by the government, businesses and individuals stood at ¥349 trillion ($3.12 trillion) — just behind 2014’s record ¥363 trillion. It meant Japan remained the biggest creditor nation for the 26th straight year, the ministry said.

There is a twist though as you might think the Yen rallies because of the money beginning to be brought home but in fact according to the IMF not so.

In contrast, we find evidence that changes in market participants’ risk perceptions trigger derivatives trading, which in turn lead to changes in the spot exchange rate without capital flows.

In essence it is expectations of a change rather than actual capital flows. I would imagine that the carry trade ( where foreign investors borrow in Yen) are a factor in this.

Swiss Franc

Many of the same factors are at play here which is why in the early days of this website I labelled the Yen and Swiss Franc as the “Currency Twins”. We can reel off negative interest-rates, trade, carry trade and so on including with a wry smile that official policy is in the opposite direction! There are two main differences the first is that there tend to be actual inflows into Swiss Francs. The second is the way that net private assets have been replaced by the Swiss National Bank. From a Working Paper from the Graduate Institute of Geneva

At the end of 2016, the Swiss net international investment position (NIIP, the value of foreign assets held by Swiss residents, net of liabilities of Swiss residents to foreign investors) reached 131 percent of GDP ……. The net international investment position of the private sector was thus close to balance in 2015, and only amounted to 24 percent of GDP at the end of 2016.

So we have seen something of a socialisation of Switzerland’s net investment position. Does that matter? I suspect so but markets seem less worried as the Swissy has rallied against the US Dollar by 0.75% to 0.9574 today.

Euro

It is hard not to raise a wry smile at the articles saying the Euro is no longer a safe haven currency as we note its rise today! Here is Kathy Lien of Nasdaq from last week with an explainer of sorts.

However the central bank’s positive economic outlook, their hawkish monetary policy bias

In future my financial lexicon for these times will have negative interest-rates and large QE as part of my “hawkish” definition. Anyway as we note that it is the countries with ongoing types of QE who are the new apparent safe havens we are left mulling the chicken and egg conundrum. Being a funding currency in the global carry trade is another consistent factor.

US Dollar

So far the era of the military dollar seems to have ended. Maybe it awaits a proper test as in an actual war but considering the stakes I would rather not find out.

Comment

So we see that a potential factor in being a safe haven currency is for official policy to be for the currency to fall? Not quite true for the Euro at least explicitly although of course it used to be expected ( outside the Ivory Towers who still do) that negative interest-rates and QE  weaken a currency. A side effect of the official effort is clearly that the QE and supply of money aids and abets those who wish to borrow in that currency and at times like this even if they do not actually reverse course markets price in that they might. The currency then sings along to “Jump” by Van Halen. You can turn the volume up to 11 Spinal Tap style if actual carry trade reversals happen.

Also there is the issue of what is a safe haven? In terms of Japan it is clearly not literal as it is in the likely firing line. We see that front-running expected trends remains the main player here as opposed to clear logical thinking. Also we see that another safe haven only flickers a bit these days as bond markets rally a bit but nothing like they used to That is another function of the QE era as how much more could they rise? Also I note that equity markets do not seem to fall that much as the FTSE 100 is off 10 points as I type this.

So a safe haven may simply be front-running? If so it means we need to dive even deeper in future as does this below for Switzerland show strength or potential weakness?

Specifically, assets held by Swiss residents abroad represent 671 percent of GDP, while claims by foreign investors on Switzerland amount to 541 percent of GDP. With this leverage, a movement in asset prices and exchange rates that affects more assets than liabilities has a sizable impact on the NIIP.

 

Could the Japanese Government cope with an end to QE in Japan?

It is time for us to look east again to the land of the rising sun or Nihon. It remains in the grip of an extraordinary economic experiment as its central bank continues to offer freshly printed Yen ( albeit electronic rather than paper ones) on a grand scale in return for bonds, commercial paper , corporate bonds, equities and property so just about everything!

With regard to the amount of JGBs to be purchased, the Bank will conduct purchases at more or less the current pace — an annual pace of increase in the amount outstanding of its JGB holdings of about 80 trillion yen — aiming to achieve the target level of the long-term interest rate specified by the guideline. …… The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

Perhaps it was the scale of all of this that led much of the media to start writing articles that the Bank of Japan would reduce its operations or as it is now called “taper” them. Only on Friday I quoted this from the Wall Street Journal.

Japan shows Europe how to dial back stimulus without spooking investors

The Bank of Japan responds

Sadly for the media the word taper required the word reverse in front of it. From the Nikkei Asian Review only a few short hours later.

At 10:10 a.m. Japan time, the BOJ unleashed what a market manager for a leading brokerage called a “devastating” combination, announcing both a fixed-rate operation, in which the central bank agrees to buy unlimited bonds at a fixed yield, and an increase in the size of regular bond-buying operations. It was the first time the bank had executed such policies simultaneously.

So more is apparently less as we note that this bit could only have come from Japan.

When yields on 10-year Japanese government bonds hit 0.1% on Thursday evening, the central bank was forced to ring up Japan’s leading securities firms for advice.

What would they have done in places like Greece Italy or Portugal in the Euro area crisis or in the early days of my career when longer UK Gilt yields passed 15%?!

By Friday morning, 10-year JGB yields had reached 0.105% — the last straw

We will have to see what happens next but should the Bank of Japan feel the need to keep intervening this could be the state of play.

If the central bank keeps buying up 10-year JGBs as quickly as it did Friday, annual purchases could exceed new issuance, according to Takenobu Nakashima of Nomura Securities, burning through fuel for measures to combat a future yield surge.

Actually if it bought them all that would of itself tend to stop any yield surge. Although of course that is just the flow so there would still be an existing stock albeit one which the Bank of Japan owes a fair bit of.

Massive bond purchases have swollen the BOJ’s balance sheet to roughly the size of Japan’s gross domestic product

Around 90% I think. There are various issues here one of which has been conveniently pointed out by the European Central Bank this morning.

Worsened liquidity in domestic government bond market

They mean in the Euro area but imagine how much worse the state of play will be in Japan. We do know that trading volumes have dropped a lot so should the day come that the Bank of Japan decides to withdraw a lot of Japanese fingers will be crossed that past traders and buyers will return. The truth is we simply do not know.

Oh and I see some looking at the equity capital of the Bank of Japan implying it could go broke. But that misses the fact that not only is it backed by the Japanese Treasury but it is pursuing Abenomics a government policy.

Number Crunching

Currently Japan owes this according to Japan Macro Advisers.

At the end of March 2017, the Japanese general government owed a total of 1270.5 trillion yen in liability, equivalent to 236.4% of GDP. The liability includes 863 trillion yen of JGBs, 115.2 trillion yen of T-bills and 157.5 trillion yen of loans.

The Bank of Japan owns over 400 Trillion Yen of these so in round numbers if it wrote these off it would reduce the debt burden to ~160% of GDP. I am by no means suggesting this but if such a situation led to a lower value for the Japanese Yen well that is government policy isn’t it? Of course the danger of debt monetisation of that form is that the currency falls heavily or plummets in a destabilising fashion like Ghana saw for those who recall when I looked at its woes.

The Yen

This has been drifting lower recently and Friday’s news added to that with it now taking more than 114 Yen to buy one US Dollar. This continues a trend which began in the middle of last month.  A sign of the Yen weakness is that the poor battered UK Pound £ is near its post EU Leave vote highs at 147 Yen.

But none of this is anything like enough to spark off the amount of inflation required by Abenomics.

The Inflation Target

More than 3 years down the road after the Bank of Japan kicked off its QQE ( Qualitative and Quantitative Easing) effort we find ourselves noting this. From Japan’s Statistics Bureau.

The consumer price index for Japan in May 2017 was 100.4 (2015=100), up 0.4% over the year before seasonal adjustment, and the same level as the previous month on a seasonally adjusted basis……  The consumer price index for Ku-area of Tokyo in June 2017 (preliminary) was 99.8 (2015=100), the same level as the previous year before seasonal adjustment, and the same level as the previous month on a seasonally adjusted basis.

This represents not far off complete failure in spite of the rhetoric about defeating deflation as if Tokyo is any guide 0% is the new 2%. Although of course we have seen asset price inflation leaving us mulling how much of the rise in the Nikkei 225 equity index from around 8000 to the current 20000 is growth and how much inflation?

Often policies to raise inflation really mean wages growth so let us look at that. From The Japan Times.

Japan’s real wages in May gained 0.1 percent from a year earlier for the first rise in five months, the government said Friday.
Total cash earnings per worker, including base and overtime pay, increased 0.7 percent to an average ¥270,241 (around $2,300), the second consecutive monthly rise, the Health and Welfare Ministry also said in a preliminary report.

You can look at this in two ways. The first is that it is not much and the second is that it is about as good as it has got over the past decade or so. One area that is different to the West where we are worrying about workers in the gig economy is that wage growth in Japan is centred on part-time work. It appears to be the one area where conventional economics can breathe a sigh of relief.

Comment

The situation continues to see some gains but also some retreats as these two quotes from The Japan Times today indicates.

Japan ‘economy watchers’ sentiment rises in June for third straight month……..Core private-sector machinery orders defied expectations and fell in May, the second consecutive month of decline, due to weakness in the service sector, the government said Monday.

Of course the UK data on Friday reminded us of the problems that sentiment indicators can have as optimism emerged as a fall!

I would like to return to my central theme that Japan has done okay in many ways with 0% inflation especially as we note its demographic problem. So why all the bond buying? Well a debt burden does of course often require some inflation to ease the burden for debtors of which the largest debtor is the government. The biggest beneficiary has been the Japanese government which has been able to do a lot of its borrowing for pretty much nothing for a while. Could it afford a return to normality? At what bond yield would it find things difficult and would it have to apply austerity? A sort of road to nowhere……

 

 

Are the currency wars still raging?

One of the features of the post credit crunch era is that economies are less able to take further economic stress. This leads us straight into today’s topic which is the movements in exchange rates and the economic effects from that. Apart from dramatic headlines which mostly concentrate on falls ( rises are less headline grabbing I guess…) the media tends to step back from this. However the central banks have been playing the game for some time as so many want the “cheap hit” of a lower currency which is an implicit reason for so much monetary easing. The ( President ) Donald was on the case a couple of months ago. From the Financial Times.

“Every other country lives on devaluation,” said Mr Trump after meeting with US motor industry executives. “You look at what China’s doing, you look at what Japan has done over the years. They play the money market, they play the devaluation market and we sit there like a bunch of dummies.”

Actually the FT was on good form here as it pointed out that perhaps there were better examples elsewhere.

South Korea has a current account surplus of nearly 8 per cent of gross domestic product, according to the International Monetary Fund, compared with just 3 per cent for China and Japan. Taiwan, meanwhile, has a colossal surplus of 15 per cent of GDP while Singapore is even higher at 19 per cent.

Care is needed here as a balance of payments surplus on its own is not the only metric and we do know that both Japan and China have had policies to weaken their currencies in recent years. So the picture is complex but I note there seems to be a lot of it in the Far East.

Japan

Ironically in a way the Japanese yen has been strengthening again and has done so by 1% over the weekend as it as headed towards 110 versus the US Dollar. So the Abenomics push from 76 was initially successful as the Yen plunged but now it is back to where it was in September 2014. Also for perspective the Yen was so strong partly as a consequence of US monetary easing. Oh what a tangled web and that.

The Bank of Japan will be ruing the rise ( in Yen terms) from 115 in the middle of this month to 110.25 as I type this because it is already struggling with this from this morning’s minutes.

The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is around 0 percent, and is expected to gradually increase toward 2 percent, due in part to the upward pressure on general prices stemming from developments in commodity prices such as crude oil prices.

Even worse for the Bank of Japan and Abenomics – but not the Japanese worker and consumer – the price of crude oil has also been falling since these minutes were composed. Time for more of what is called “bold action”?

Germany

It is not that often on these lists because the currency manipulation move by Germany came via its membership of the Euro where it added itself to weaker currencies. But its record high trade surpluses provide a strong hint and the European Central Bank has provided both negative interest-rates and a massive expansion of its balance sheet as it has tried to weaken the Euro. So we see that an exchange-rate that strengthened as the the credit crunch hit to 1.56 versus the US Dollar is now at 1.086.

So the recent bounce may annoy both the ECB and Germany but it is quite small compared to what happened before this. Putting it another way if we compare to Japan then a Euro bought 148 year in November 2014 but only 120 now.

The UK

In different circumstances the UK might recently have been labelled a currency manipulator as the Pound £ fell. As ever Baron King of Lothbury seems keen on the idea as he hopes that one day his “rebalancing” mighty actually happen outside his own personal Ivory Tower. There is food for thought for our valiant Knight of the Garter in the fact that we were at US $2.08 when her bailed out Northern Rock and correct me if I am wrong but we have indeed rebalanced since, even more towards our services sector.

However it too has seen a bounce against the US Dollar in the last fortnight or so and at US £1.256 as I type this there are various consequences from this. Firstly the edge is taken off the inflationary burst should this continue especially of we allow for the lower oil price ( down 11.2% so far this quarter according to Amanda Cooper of Reuters). That is indeed welcome or rather will be if these conditions persist. A small hint of this came at the weekend. From the BBC.

Motorists will see an acceleration in fuel price cuts over the weekend as supermarkets take up to 2p off a litre of petrol and diesel.

Not everybody welcomes this as I note my sparring partner on BBC 4’s MoneyBox Tony Yates is again calling for higher inflation (targets). He will then “rescue” you from the lower living-standards he has just created….

The overall picture for the UK remains a lower currency post EU vote and it is equivalent to a 2.5% reduction in Bank Rate for those considering the economic effect. Meanwhile if I allow for today’s rise it is pretty much unchanged in 2017 in effective or trade-weighted terms. Not something in line with the media analysis is it?

South Africa

This has featured in the currency falling zone for a while now, if you recall I looked at how cheap property had become in foreign currencies. There had been a bounce but if we bring things right up to date there has been a hiccup this morning. From the FT.

The rand plunged almost 2 per cent in less than half an hour on Monday morning after the latest row between president Jacob Zuma and his finance minister Pravin Gordhan, only moments after it had risen to its highest level since July 2015.

Perhaps the air got a bit thin up there.

The rand has been the best-performing currency in the world over the last 12 months, strengthening more than 23 per cent against the dollar, but it has suffered a number of knock backs prompted by the president and finance minister’s battles.

Back to where it was in the late summer of 2015.

Bitcoin

If we look at the crypto-currency then there has been a lot of instability of late. At the start of this month it pushed towards US $1300 but this morning it fell to below US $940 and is US $991 as I type this. Not for widows and orphans…

Comment

There is much to consider here as we wonder if the US Dollar is merely catching its breath or whether it is perhaps a case of “buy the rumour and sell the fact”. Or perhaps facts as you can choose the election of the Donald and or a promised acceleration in the tightening of monetary policy by the US Federal Reserve. But we see an amelioration in world inflation should this persist which of course combines as it happens with a lower oil price.

So workers and consumers in many countries will welcome this new phase but the Bank of Japan will not. Maybe both Euro area workers and consumers and the ECB can as the former benefit whilst the latter can extend its monetary easing in 2017 and, ahem, over the elections. Whilst few currencies are stable these days the crypto one seems out of control right now.

Is this a genuine “currency war” or just happenstance?

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.

China

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.

Sweden

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?

Yen

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.

Euro

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.

Comment

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.

Is the lack of lining on UK ladies coats this season another example of and has made a quality adjustment in its numbers?

Me on Tip TV Finance

Post-trump moves: Like old times, but not exceptional times – Shaun Richards

 

 

 

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