The U.S. dollar’s surge to new highs, even as monetary authorities around the world jack up interest rates or intervene to support their domestic currencies, shows that central banks fighting the ‘reverse currency war’ are doomed.
In the battle against an ultra-hawkish Fed, there is only one winner: the dollar.
The third week of September 2022 has gained instant historic status as the Federal Reserve’s third consecutive rate hike of 75 basis points - and promise of more tightening to come - sent global markets crashing, and the dollar to the moon.
Unfortunately for the rest of the world a rampant dollar is an economic and financial wrecking ball that takes down most things in its path. And the destruction left in its wake only makes investors more likely to shun crumbling currencies in favor of the greenback, thereby intensifying the vicious cycle.
Look at Sweden. The Riksbank stunned markets with a 100 basis point rate hike, the most since 1993, yet the Swedish crown tumbled to a record low against the dollar, plunging more than 4% in the week.
The European Central Bank’s unprecedented 75 basis points rate increase the week before and promise of more to come failed to prevent the euro from slumping to a 20-year low of $0.97 on Friday.
The term ‘currency wars’ was coined by Brazilian Finance Minister Guido Mantega in 2010, in the aftermath of the global financial crisis when weak exchange rates in developed economies helped stimulate growth and stave off deflation.
The global wave of post-pandemic inflation, however, has flipped that on its head, and central banks are now in a race to raise rates and kill off inflation. The ‘reverse’ currency war against the Fed and the dollar is far harder to win.
An IMF working paper in July looking at FX interventions across 26 advanced and emerging economies between 1990 and 2018 found that “intervening to reduce exchange rate misalignments arising from long-run macroeconomic factors is not likely to be effective.”
What’s more, it also found that “FX sales appear to be somewhat more effective than FX purchases, and intervention is less effective in more liquid FX markets.”
In essence, central banks are more likely to achieve their aims in a traditional ‘currency war’ selling their currency to keep it weak and competitive, than when they are intervening to buy their currency with dollar reserves.
The dollar wrecking ball’s blows are being felt globally, but are perhaps most painful in Tokyo and London.
The yen’s slide to a 24-year low against the dollar prompted the Bank of Japan’s first dollar-selling intervention since 1998, and sterling’s plunge to a 37-year low and equally historic slump in gilts have backed the Bank of England into one of its tightest corners ever.
Their fragility is telling.
The BOJ joined a growing number of Asian central banks to intervene selling dollars for their domestic currencies, finally stepping in to stop the yen from sliding towards the 150/dollar mark. But analysts are skeptical it will have a lasting impact.
The BOJ has $1.3 trillion in FX reserves, mostly dollar-denominated. As much as that is, however, it is still a limited amount, so the BOJ’s yen-buying firepower is also limited.
Yen-buying intervention from the BOJ is also less likely to succeed as long as the BOJ is anchoring Japanese interest rates close to zero and the Fed is yanking U.S. rates ever higher.
The BoE, still scarred by ‘Black Wednesday’, Sept. 16, 1992, when sterling’s collapse forced Britain to exit the European Exchange Rate Mechanism, has not intervened to support the pound.
But calls for it to act are mounting, especially following the market’s backlash against the government’s mini budget on Friday of huge tax cuts and spending increases.
The pound sank 3.5% against the dollar on Friday. There have only been six steeper daily declines since the onset of free-floating exchange rates 50 years ago.
The gilt market’s crash this week was even harder. The five-year yield rose almost 100 basis points in the week, by far the biggest rise on record, while the 10-year yield shot up almost 70 bps, the most since 1981.
“The policy response required to what is going on is clear: a large, inter-meeting rate hike ... as soon as next week to regain credibility with the market,” Deutsche Bank’s George Saravelos wrote on Friday.
The dollar, meanwhile, marches on. HSBC’s global multi-asset allocation now holds ‘maximum’ underweight positions in equities, high yield credit and developed market sovereign bonds, the bank says, adding: “The only major asset class that holds up is dollar cash.”
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