It’s certainly “a moment” in currency markets as the world watches the dollar flail relentlessly and the yen - and the euro - sail on at levels (Y100 and $1.56, respectively) barely imagineable even 10 days ago.
Everyone, of course, has their two cents worth on this - it’s due to Carlyle Capital’s near-collapse, it’s due to bank bail-outs, it’s due to Fed moves etc. etc. But for what it’s worth, here’s a few of the more thought-provoking reactions to the dollar’s breathtaking dive - beginning with the FT’s (qualified) call on Friday for governments to undertake a bit of sensible currency intervention.
Selling the dollar is now close to a one-way bet, the FT says in its Friday editorial comment. Aggressive rate cuts and fears that US taxpayers will have to bail out their banks are not only undermining the currency, but making a surge in US inflation more likely.
So, given the growing danger of a complete dollar rout, the Fed, ECB and Japan’s Ministry of Finance should “co-ordinate intervention to slow the greenback’s fall”, in the FT’s view. On past form, Japan “must be close” to unilateral action but a joint move with the ECB and the Fed “would be better and more likely to succeed.”
But it would, of course, be “pointless, foolish and wrong” to try and fix the dollar at its current level, the FT adds.
Markets are the best way to determine exchange rates, and on a trade-weighted basis it is far from clear that the dollar has overshot its fair value. But what intervention might do is slow the decline, by putting fear in the minds of momentum investors who are selling short on margin.
Among the prerequisites for - er, sensible - and “successful” intervention, in the FT’s view, are: first, “limited objectives”; second, “co-ordination”; and third, “co-operation, if not the active aid, of Asian nations that manage their currencies against the dollar”.
Intervention is never ideal – some of today’s problems stem from past manipulations – and there are large risks, most notably that central banks fail and lose credibility. But if the above conditions can be met, some action to stabilise the dollar would be a sensible part of the response to global financial turmoil.
Meanwhile, in a Thursday note on what he calls a “sea change in currency markets”, Ashraf Laidi, chief forex strategist at CMC Markets, notes the attainment of quadruple parity, with the dollar hitting 1.0000 in Swiss francs, Y100 in and the breach beyond 1.0000 in Australian dollars and $1,000 per ounce in gold.
Laidi lays some of the blame for the dollar’s latest slide on the woes at Carlyle Capital Corp.
The continued damage in the mortgage backed securities market dealt a blow to Carlyle’s collateral, all of which was AAA rated. Notably, the fact that the funds parent company, private equity giant Carlyle Group had failed to successfully provide sufficient capital to lenders not only reflects the speed of the fall in value of these securities, but suggests further similar failures amid other leveraged private equity companies.
Thursday’s declines in US stocks mean that Tuesdays unprecedented announcements by the worlds major central banks to inject over $230bn in security lending failed to have a lasting effect on market confidence beyond one day. Tuesday’s 400-point rally in the Dow was fully reversed the next day, while the S&P500s surge from 1275 to 1323 is now reversing back towards the 1290 level in the futures market. Renewed selling in equities will mean broader strengthening in the yen and the Swiss franc as capital surges back to these funding currencies.
Momentum appears to be building behind the euro, in Laidi’s view - not least as reports from the Gulf Co-operation Council countries regarding an end to the dollar-peg continue to favour the euro. With gold probing the $1,000 mark, Laidi expects the euro to regain momentum towards the 1.5650 target.
So over to Japan - which is watching aghast as the yen surges amidst a sharp unwinding of carry trades. As Laidi notes, attempted verbal intervention by Japan’s vice finance minister for international affairs did nothing to stop the yen’s rally. Don’t expect the yen to have any “meaningful retreat” in its latest rally unless Japanese officials either threaten to intervene or carry out the intervention then announce their actions, adds Laidi.
Part of the reason why Japan has not yet moved, he notes, is the contrast in GDP growth rates between the US and Japan, with the latter up 3.5 per cent in Q4 and the former up 0.6 per cent, “which implies that Japanese officials cannot adopt the same mantra of 2003-04 (last time they had intervened) of indicating that currency moves do not reflect fundamentals”.
In the event that Friday’s expected speech from Treasury secretary Hank Paulson regarding the government plans to assist home buyers offers a boost to stocks then we could see a temporary rebound in USD/JPY and rest of yen crosses. USD/JPY upside, in Laidi’s view, is seen capped at 101.65-70, with substantial downside pressure at 100.90. But expect a renewed attempt, he says, to retest Y99.95, followed by Y99.70.
Finally, from Tohru Sasaki, JP Morgan’s ever-savvy Japan currency strategist, who issued a note in January predicting Y98 to the dollar “within March”.
As per his earlier note, Sasaki still thinks Tokyo is unlikely to directly intervene on the yen before the end of the year - even though he has revised his prediction that the yen would hover around Y100 to the dollar and now thinks it is will move higher than Y98 in coming weeks.
Three key reasons for this are: first, that the recent USD/JPY decline is still being led by general dollar weakness and not independent yen strength. As a result, the yen remains “relatively weak at the crosses”. He believes Japanese institutional investors are still more exposed to EUR/JPY than USD/JPY. Should EUR/JPY start declining more sharply from here, hedging flows could intensify to drive further yen buying, which could drive USD/JPY well below Y98, even if Japanese retail investors start buying foreign assets, he says.
Second, Japanese exporters are still hesitant to sell the yen. The budget rate for Japanese exporters is around Y105, “way above current spot”, says Sasaki. The direct implication is that most Japanese exporters have failed to hedge their exposures over the past month. Risks are that once the budget rates are lowered in line with market developments, renewed hedging flows could drive USD/JPY lower.
The final reason, he says, is that Japanese investors are likely to curb their seemingly insatiable appetite for foreign currency assets. “Indeed, the magnitude of outflows may decline as Japanese stocks fall (leading risk appetites lower) and as Japanese investors are already overweight foreign assets.
