Feb 17, 2016
Technically, this is not a currency war. Central banks around the globe are easing monetary policy not in an effort to devalue their currencies but in another desperate move to bolster economic growth and prevent deflation.
But as far as currencies are concerned, it is still looking like a beauty contest, and a contest that the dollar is more than likely to win – if being the most attractive currency is actually a good thing.
It all started last December when, after months of dithering, the Federal Reserve decided that the US economy was strong enough to withstand the first rise in interest rates since the financial crisis erupted in 2008.
Of course, no sooner had this been done than new fears about global growth sent equity markets into a tailspin and bets on further rate rises in the US slithered off the table.
Some softer US economic data since the start of the new year only added to the impression that market expectations of another four rate hikes this year was clearly wrong, with Fed officials themselves acknowledging that the next move remains unclear given global uncertainty.
Even so, the upward direction of US interest rates remains firmly in place and some analysts reckon that the Fed may well resume tightening sooner than expected.
Take Marc Chandler, global head of currency strategy at Brown Brothers Harriman. “While we doubt that the Fed will hike rates four times this year… we suggest the market may be underestimating the implications of full employment and the prospects of (gradually) rising core inflation by discounting only one hike this year,” he says.
However, it is not so much the “beauty” of the dollar that will see it win the contest but the lack of beauty in the other major currencies that will ensure it gets the trophy.
A stark reminder of this came from Japan, which surprised investors by reducing one of its interest rates into negative territory even though Bank of Japan Governor Haruhiko Kuroda had only just appeared to deny that such a move was being considered. And the cut in the rate to -0.1% may just be the start, with some forecasters, such as Marcel Thieliant at Capital Economics, looking for a fall to -1.0% by the end of the year as the central bank abandons its recent policy of “quantitative and qualitative easing” and relies more on rates to to get its sluggish economy going again.
This comes against a background of similarly aggressive tactics by China, where a string of disappointing economic data helped to trigger the most recent meltdown in global markets. Even more-optimistic economists, who still hope that China will avoid a hard landing, are now expressing doubts that it can.
“If the economy doesn’t show signs of a turnaround in coming months, we would have to downgrade our relatively upbeat view of China’s economic prospects,” warns Capital Economics’ chief China economist, Mark Williams.
In the meantime, more stimulus measures can be expected from Beijing, increasing the belief that the Fed is the only central bank moving in the other direction.
In Europe, the European Central Bank has reinforced this impression. It had been hoped that the recent declines in oil prices and inflation would have helped the economies of the eurozone to stabilise. But it now appears that the benefits from these have been brief and that the ECB will be forced to pursue further policy easing if the recovery in the region is to be sustained.
Its president, Mario Draghi, was long expected to seek some further easing in March. But now, as analysts at Rabobank say, he has “upped the ante” in a speech “paving the way for what could prove a more aggressive than expected move.”
So with the euro, the yen and the yuan under pressure from further monetary easing expectations and with commodity currencies likely to suffer from the continued concerns over global growth, the dollar remains the most likely major currency to stand out, offering returns where others cannot.
Nicholas Hastings has written insightful analysis of breaking news, the financial markets and global political and economic developments since 1981, including a daily column on the foreign exchange markets for much of the last 20 years.