The past couple of weeks’ events and price action have yielded some interesting insights with respect to the major currencies of the dollar, the yen and the euro. This relates particularly to the intentions and possible actions of the monetary authorities in the US, Japan and the Eurozone and how they could influence the respective exchange rates.
Starting with the yen, the Bank of Japan surprised markets the previous week with its announcement of negative interest rates. The yen nosedived on the news, as dollar / yen rose from around 118.50 to a high of 121.50. It appears that the Bank of Japan wanted to surprise the markets and particularly foreign exchange, as there was little indication that such a move to negative rates was being contemplated. In fact, the Bank of Japan Governor specifically spoke against the possibility of negative rates some days before the announcement. According to some news articles concerning the Bank’s decision, the plan was even kept secret from board members until days before the decision. It is worth remembering that the rate cut was approved by the narrowest of margins by the board with only a 5-4 majority.
Although the BoJ appeared to be initially successful in its goal to drive the yen lower, this week turned the tables on it. Statements on Wednesday by the New York Fed President William Dudley, which showed concern about recent global economic and financial developments as well as the negative effect further dollar appreciation might have, provoked selling of the US dollar and a reassessment of possible future Fed rate hikes. Eventually dollar / yen dropped below the 117 mark as risk aversion also caused safe haven buying of the Japanese currency. The lesson however is that for the yen to become weaker as Japan’s central bank and probably its government intends, it might not be so easy. Dollar / yen has risen from the 80 level to around 120 because of the aggressive quantitative easing campaign, but further depreciation of the Japanese currency might prove harder despite the new monetary tools which are being used for the first time in the country. Their effectiveness in boosting inflation or economic growth might also be questionable.
Another currency that has depreciated substantially in the past year and a half or so has been the euro. Policywise, despite letting down the market during the previous December meeting by not enlarging QE, the ECB chief again appeared ready to take action during the next meeting in March. In the euro’s case as well, there was an initial drop right after Draghi promised a reassessment of policy in March, but subsequent dollar weakness and risk aversion helped the euro rise to a 1-year high on a trade-weighted basis. Therefore the ECB has also been failing in its efforts to drive its currency lower in order to support the region’s exports. The ECB’s problems are understandable if one takes into account the substantial drop of the single currency from around 1.40 versus the dollar to as low as 1.04.
The one central bank that has seen the pressure on it decline because of the dollar’s weakness has been the People’s Bank of China. The yuan’s exchange rate with the US dollar is one that is keenly watched by investors and the market and the fact that the pair has stabilized lately has given the opportunity to the Chinese authorities to probably catch their breath after spending hundreds of billions in reserves in defense of the yuan. At the same time, this respite gives the opportunity for the Chinese authorities to try to shift the focus to the yuan’s relationship with a basket of currencies rather than the headline-grabbing relationship with the dollar.
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