Good morning,
Time to take a breath
A tough week is coming to an end; the yen remains strong and the largest drop in 2 months on US stock markets have continued to drive sentiment into the dirt.
Through the Asian session the Japanese yen has shrunk back from its 17 month high following another round of verbal intervention. The broad sell off that has been seen in Asian assets is unabated this morning with many traders simply clinging on for the weekend. Needless to say volatility through currencies has been high and is back up to the levels seen in February. These were in turn the highest since 2011.
Of course, volatility abounds when policy measures become divergent and confused as they are now. Most economists have joined us in calling for a June rate hike from the Federal Reserve. It is heartening to see that the US economic story has not deviated much in the fortnight that I have been away. Indeed, the comments from Fed Chair Yellen that slack in the US labour market remains despite the US economy’s “tremendous progress”.
Currency wars and warts
Currency wars are very much back on the radar given the movements in Japan. Nations have engaged in the practice of competitive devaluation of currency to try and kick-start growth by boosting their exports. It’s questionable whether this practice has ever really worked effectively. Before the 19th century, huge amounts of trade between countries were rare and therefore relative exchange rates were not much of an issue. Devaluation did occur but mainly via reducing the amount of gold and silver used within the actual tokens of money in the economy.
With the advent of global trade exchange rates became more relevant and then came the Great Depression. Countries devalued their currencies within quick succession of each other in order to try and gain an advantage. None really came for anyone and following a collapse in global trade the world moved into the Bretton Wood’s system of semi-fixed rates until the 1970s exactly to prevent this kind of thing from happening again.
Following the collapse of Bretton Woods in 1971, most major currencies have once again become free floating and therefore susceptible to a competitive devaluation.
In my eyes Asia has always been the spiritual home of the currency war. From the devaluations of the Asian Crisis of the late 90s through Japanese led quantitative easing to the constant positioning battles of the People’s Bank of China, hostile currency policy is a hallmark of Asian international markets.
Can the dollar come higher?
US Fed futures, the probability of an interest rate hike at certain points in the future, show that the market is only pricing in a 15.7% chance of a rate hike on June 15th. The dollar’s weakness is a double edged sword for these markets at the moment; they have allowed oversold currencies like the yen and euro rebound but the Fed can’t really sit there and worry about future near-term hikes in interest rates on the US dollar.
Although the price may not reflect it at the moment I would not be surprised if the fact that the June Fed meeting takes place only 8 days before the UK referendum on EU membership. The Fed have held off on rate hikes this year already due to their innate fear of extraordinary market risk; if the vote looks like it is going down to the wire then we would expect some reticence on the part of the US rate setters.
For now we must continue to look to the East.
Have a great day and a better weekend.