Morgan Stanley’s currency expert and emerging markets strategist Stephen Jen has been quick to leap on the significance of the push to give the IMF extra funds to channel to Eastern Europe. Citing what he calls a “game changer” for forex markets – and for Europe in general – Jen has changed his hitherto bearish outlook on the euro and now thinks it’s more likely to see $1.40 next than $1.20 – a significant shift from the $1.10-$1.15 he has been looking for up to now.
In his first big shift on the euro since “the start of the global financial crisis”, Jen says the prospective $750bn-$850bn “IMF arsenal” will effectively bail out Eastern Europe and the likes of Austrian and other European banks with large exposure to those regional emerging markets:
The ‘EE-EMU Nexus’ has been the main reason for his consistent bearishness on the euro up to now. A massive IMF infusion would be “as much a bail-out for the likes of Austrian, Italian, German, Swiss and Swedish banks as it would be for Eastern Europe,” he notes.:
Following their meeting last Monday, the EU issued their first explicit endorsement of the proposal made by the IMF to double its resources from US$250 billion currently to US$500 billion. However, last Wednesday, US Treasury Secretary Geithner upped the ante by proposing that the IMF’s NAB/GAB be increased from the current US$50 billion to US$500 billion. Depending on whether the US$100 billion special credit line from Japan is counted, total usable IMF resources could, in the Treasury’s plan, rise from US$250 billion currently to US$750-850 billion. I am not too worried about a lack of explicit commitments from various countries at the G20 gathering this weekend, because for any country to openly endorse this idea, they will be expected to contribute. Reserves-rich EM economies will only contribute if there is a commensurate increase in their representation at the IMF, as referred to in the joint statement from the BRIC economies. I believe European countries will eventually make concessions on this issue.
If it proceeds, IMF action on Eastern Europe is a “game changer”, for both the EE currencies and the euro – and perhaps even the Swiss franc, he says.
$850 billion is a massive amount of liquidity, particularly because none of the AXJ economies will likely access funds from the IMF, and only a couple of LatAm economies could turn to the IMF. This leaves most of the US$800 billion or so of resources available to the EE — an amount equivalent to roughly 60% of EE GDP (not including Russia).
Some sales of US Treasuries and German bunds may be likely, he notes:
When a creditor country contributes to the IMF (either in the form of a lump sum transfer or as the money is drawn on an as-needed basis, such as in the case of Japan’s US$100 billion bilateral line), the underlying reserve holdings will need to be converted into cash. This, mechanically, implies some sales of US Treasuries by the creditors before the funds are transferred to the IMF…However, to the extent that central banks maintain the currency composition of their foreign currency holdings, there could actually be net sales of EUR/USD. Thus, mechanically, transfers to the IMF might be EUR/USD-negative, in theory, notwithstanding my new ‘call’ on EUR/USD.
In another bold call, Jen also sees the possibility of a “CHF bloc” following “clearly remarkable” interventions by the Swiss National Bank last Wednesday. “Remarkable” because the SNB is the “only central bank in the world that has openly and officially (in contrast to Taiwan) intervened to drive down the value of its currency”. Most other countries have been intervening to support their own currencies, he says, noting:
Small economies can do quantitative easing through foreign exchange, but not big economies. Japan, for example, is unlikely to be permitted by global authorities to undertake this type of QE, even though the idea was suggested back in 2002, by Mr Bernanke himself. (I’m not saying that Japan needs ‘permission’ from anyone to do anything. My point is that the global community has a different standard for the G3.)
Similarly, the US wouldn’t be allowed to intervene to artificially push down the USD to offset inflationary pressures. China will most likely refrain from a large step devaluation, for the same reason.
Jen sees similarities between the Swiss and Singaporean economies, while their monetary/exchange rate policies are too divergent:
Given the weaker economic fundamentals of Singapore, compared to Switzerland, the Monetary Authority of Singapore has compelling reasons to be more aggressive with their NEER [nominal effective exchange rate] policy, he notes. In conclusion, says Jen, watch for a ‘CHF-bloc’ in the period ahead, as far as exchange rate policies are concerned, with the central banks of Korea, Taiwan and Singapore likely show a weak currency preference, like the SNB.
Getting the IMF to take the heat – FT Alphaville
Ministers agree on need to boost IMF funds – FT
The Swiss franc factor – FT Alphaville
Swiss franc intervention – Short View
Swiss stoke fears of currency wars – FT
On your marks, get set, devalue – FT Alphaville