LONDON: If 25 countries cutting rates since the start of the year wasn’t proof enough, this week’s warning from Janet Yellen about the dollar’s strength confirmed that the world’s top central banks are fighting a currency war.
The scale of global easing has been the big surprise for investors this year.
On average an interest rate has been cut somewhere in the world once every 2.85 days, and everybody’s been at it.
From the European Central Bank with its one trillion euro QE bazooka, China, India and Russia in emerging markets, to Denmark and Switzerland where rates are now so negative that it would be cheaper for anyone with serious money to rent a vault and some heavies with machine guns than to keep it at the central bank.
But this week has seen a dramatic shift in the front line of the battle.
As the central bankers’ central bank, the Bank for International Settlements (BIS) put it last Wednesday, “easing begets easing.” Institutions like the BIS prefer to avoid emotive phrases like “currency wars”, but the message was clear.
Later that day Federal Reserve chief Yellen ran out of “patience”. Markets had been waiting for her to remove the word in reference to the bank’s view on raising rates.
She did, but it was her subsequent warning that the dollar’s 25% rise over the last nine months could have a “notable drag” on the US economy that signalled the Fed was joining the currency battle too.
The dollar saw its biggest daily fall against the euro in six years and against all major currencies in 2½years, which also triggered wild moves in global stock, bond and commodity prices.
It wasn’t only the United States that was agitating either.
The Bank of England, the only other major central bank expected to raise interest rates any time soon, fired a warning about sterling’s strength and Sweden stunned markets with a surprise rate cut and increase to its QE programme.
“This is the name of the game now,” said Hans Peterson, global head of asset allocation at SEB investment management.
“There is slow growth everywhere and that puts put more emphasis on the currency parameter.” With growth unlikely to ramp up soon, he said, central bankers were likely to continue threatening further easing to try and to pressure on their currencies and squeeze out every drop of growth they can.
“If you think about global investing, it (currency war) is the most important variable we have right now,” Peterson added.
“We like to try to catch that effect.”
The stats back Peterson’s view. European equity funds have seen record inflows this year as investors have made big bets that the 25% drop in the euro against the dollar over the last year will lead to bumper sales for the region’s firms.
And anticipating the dollar’s rise, big multi-billion dollar mutual funds have been scaling back on assets that are not dollar denominated, seismic moves which have fuelled much of the euro and emerging market selling.
But with the frontline in the battle clearly shifting this week after the Fed and BoE interventions, investors may have to think more carefully about their options.
The dollar has long borne the brunt of other currencies’ weakness, effectively allowing these countries to export their deflation to the US economy, which has been relatively strong so able to cope with the downward pressure exerted on growth.
But according to David Bloom, global head of currency strategy at HSBC, any further dollar strength from here would likely be “dark and destructive” for all asset classes, emerging markets, and central banks’ policymaking.
Stocks are becoming more sensitive to further bouts of dollar strength, dollar-denominated debtors in emerging markets are becoming increasingly twitchy, and as central bankers have shown this week, so are policymakers.
Bloom and his team went against the overwhelming market consensus on Thursday, raising its euro forecast to US$1.20 by the end of 2017. Two of its main peers, Goldman Sachs and Deutsche Bank, this month slashed their euro forecasts to US$0.80 and US$0.85, respectively.
“The dollar’s strength up to now has been constructive and good for the world. But the sweet spot is over,” Bloom said. – Reuters
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