Column: The upside-down world of “reverse currency wars” is real


Euro, Hong Kong dollar, US dollar, Japanese yen, pound and Chinese 100 yuan banknotes are seen in this illustration in Beijing, China, 21 January 2016. REUTERS/Jason Lee

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LONDON, June 22 (Reuters) – An upside down world of ‘reverse currency wars’ seeps into the real one.

Fans of Netflix hit Stranger Things know how chaos and monsters from the show’s foreboding parallel universe invade everyday life with devastating effect. Continue reading

Something similar appears to be happening with one of the dominant economic policy tropes of the past decade.

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Financial firms like Goldman Sachs have been warning for months that long-fought “currency wars” — in which countries struggle to keep a weakening US dollar and overvalued domestic currencies from hurting exports — could be reversed, with frightening consequences.

They call this dodgy policy zone “reverse currency wars” and posit that resurgent inflation, a hawkish Fed and dollar strength would force governments and central banks to reconsider exchange rate orientations and race to keep up.

In the decade after the US Federal Reserve first began quantitative easing bond purchases to stave off deflation, many countries lamented that the resulting dollar weakness was hurting their trade in a low-growth world and forcing them to overheat by would try to keep up with the Fed’s easing money.

But all that changed after the Fed’s aggressive turn this year to curb 40 years of high inflation with significantly higher interest rates, a halt to new asset purchases and a planned downsizing of its bloated balance sheet of more than $8 trillion.

The result has been a skyrocketing dollar, the index of which has risen nearly 20% against other major currencies over the past year – posing the opposite problem for US trading partners that they are trying to prop currencies rather than limit them for fear that their weakness in the dollar price would make energy and food imports even more expensive, exacerbating sky-high inflation everywhere.

In the past week, “reverse currency wars” have become increasingly a reality.

The reversal was most evident in the Swiss National Bank’s shock rate hike on Thursday, an apparent shift in its overall policy of suppressing the Swiss franc to stave off deflation to its strength as a tool to cool imported inflation. The change is potentially seismic, given its consistent policies that have resulted in it amassing more than $1 trillion in foreign exchange reserves in the process. Continue reading

“The move validates our bullish view on the franc and is the strongest evidence yet for our ‘reverse currency wars’ thesis – the era of weaker exchange rate bias is over,” Goldman’s currency team told clients, adding that the Analysis showed a 1% franc rise cut inflation by 0.1/0.2 points and said the SNB would likely target a 5% hike in the franc’s real exchange rate.

Dollars percentage gains over the past year
G4 inflation rates since 2000


But it’s not alone. This week, Bank of England policymakers made it clear they too are debating this upside-down world and are nervous about sterling’s 14% decline against the dollar in just 12 months and a 5% trade-weighted decline in sterling alone in watch this year.

On Monday, BoE rate setter Catherine Mann said one of the reasons she voted to hike rates by half a point last week, rather than the quarter-point delivered, was to stave off additional “inflation imported by sterling depreciation.” “. Continue reading

Although her colleague and BoE chief economist Huw Pill on Tuesday downplayed the explicit targeting or “fine tuning” of sterling – a taboo in the UK since sterling was excluded from the European exchange rate mechanism 30 years ago – the cat seems out of hand to run bag. The pound is certainly an important factor.

An increasingly hawkish European Central Bank is also facing record high inflation in the euro zone, exaggerated by a blinding rise in energy prices and a nearly 15% fall in the euro against the dollar over the past year.

As recently as last month, the head of the Bank of France, Francois Villeroy de Galhau, warned against an excessive weakness of the euro: “Too weak a euro would run counter to our price stability goal.” Continue reading

Japan is in a bigger pickle. She speaks almost daily of excessive yen weakness – now at a 24-year low against the dollar – even as the Bank of Japan maintains its policy of capping government lending rates by buying billions of dollars in bonds amid creeping inflation and rising yields around the planet.

How long Tokyo can go on with the latter while fretting over the former is hard to say.

Emerging markets – many of which face far more destabilizing food and energy price inflation – have already tried to forestall tightening by the Fed over the past year. But more dollar strength could force them to tighten the screw at a dangerous time.

The big risk, in the eyes of many people, is that the Fed’s promise of an “unconditional” war on inflation will continue to hurt the dollar in a world where dollar price increases in commodities are bolstering inflation expectations everywhere and forcing everyone else to ape the US central currency puts pressure on the bank, for better or for worse. Continue reading

Citi strategist Ebrahim Rahbari believes this all points to global “over-tightening” — a prospect that is “deeply troubling” for global markets, with lower equities, flatter bond yield curves and severe pressure on financial conditions.

“Reversal currency wars are sharply bearish for risky assets,” he said, adding that currencies of more dovish central banks and fragile economies are the most vulnerable.

If such a crisis accelerates a global downturn, the Fed could be under a lot of pressure to retreat. But war-related energy problems, tight post-pandemic job markets and political pressures ahead of the US congressional election in November argue against a slowdown this year.

The upside down world seems to stay here.

Key interest rates of the major central banks since 2000
EM central bank interest rates since 200

The author is the finance and markets editor at Reuters News. All views expressed here are his own.

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by Mike Dolan, edited by Tomasz Janowski Twitter: @reutersMikeD

Our standards: The Thomson Reuters Trust Policy.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias under the Trust Principles.


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