Fed re-ignites currency war (or currency skirmish)

September 19, 2012

The currency war is back.

Since last week when the Fed started its third round of money-printing (QE3), policymakers in emerging markets have been busily talking down their own currencies or acting to curb their rise. These efforts may gather pace now that Japan has also increased its asset-buying programme, with expectations that the extra liquidity unleashed by developed central banks will eventually find its way into the developing world.

The alarm over rising currencies was reflected in an unusual verbal intervention this week by the Czech central bank, with governor Miroslav Singer hinting at  more policy loosening ahead, possibly with the help of unconventional policy tools. Prague is not generally known for currency interventions — analysts at Societe Generale point out its last direct interventions were conducted as far back as 2001-2002.  Even verbal intervention is quite rate — it last resorted to this on a concerted basis in 2009, SoGen notes. Singer’s words had a strong impact — the Czech crown fell almost 1 percent against the euro.

The stakes are high — the Czech economy is a small, open one, heavily reliant on exports which make up 75 percent of its GDP. But Singer is certainly not alone in his efforts to tamp down his currency. Turkey’s 100 basis point cut to its overnight lending rate on Tuesday (and hints of more to come) was essentially a currency-weakening move. And Poland has hinted at entering its own bond market in case of “market turmoil”

What of Latin America and Asia, the main battlegrounds for currency wars of the past? As may be expected, Brazil has been the most vocal in its criticism of the Fed — its finance minister Guido Mantega (who first came up with the currency wars phrase) has threatened more measures to keep a “devalued real” .  The central bank has already sold billions of dollars worth of reverse currency swaps to weaken the real this week. Neighbouring Peru on Tuesday waded into currency markets to weaken the sol, saying the central bank was trying to get in ahead of an expected wave of inflows. In Asia, central banks from the Philippines and Taiwan have been spotted buying dollars to weaken their currencies while Korea will almost certainly cut interest rate to curb its won which is near  six-month highs to the dollar.

All that sounds pretty familiar.  But are emerging economies really that worried?  And should they be?

A competitive currency looks even more desirable now than two years back, given that global trade and exports are in the doldrums.  But it’s pretty clear to all that no matter how much QE the Fed does, emerging currencies — and economies — do not look as attractive a bet as they did back in 2010 (see here for an article on this). Already the post-Fed currency rally has run into trouble as new worries surface over the euro zone. China’s reluctance to emulate the Fed with its own stimulus programme is also dampening sentiment.

So it’s quite possible this year’s currency war will be more of a skirmish. Imran Ahmad, an emerging markets strategist at RBS says:

Additional liquidity is one element to the solution but the second thing people are waiting for is for growth to carry the baton…whether we will see growth start to pick up. What markets are looking for is for signs that growth is bottoming out in the big emerging economies.

Ahmad reckons all these waves of QE will inevitably push emerging currencies higher against the dollar but he also cautions:

Post-QE1 we saw a multi-quarter rally in EM currencies, post-QE2, we had a multi-month rally. Our view is that after QE3 we will get a multi-week rally.


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