Early September skirmishes turned this week into full-scale “currency wars”, to use Brazil’s terminology. Dramatic language, but not unwarranted. The markets have taken Fed signals of preparation for further money printing as an effective attempt at a dollar devaluation, allowing the country export its deflationary pressures overseas via capital outflows to higher-yielding developing countries.

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The major developing nations, for all the arguments favouring currency revaluations of 20-25% over the next couple of years, are not going to stand idly by and watch that happen overnight. But their attempts to offset the impact of soaring local currencies and attendant asset bubbles merely floods local economies with cash at a time when fighting inflation — not deflation — is their priority. Brazil has raised the red flag, but the likes of Turkey and Taiwan are also registering fears about the impact of another bout of US monetary pump priming. Meantime, the gloves are off in the US-China yuan row; possible trade measures are being invoked in DC; and there is little chance of cooler heads prevailing this side of the US mid-term elections. This story will run.

What’s certain is the G20 finance meeting in South Korea on Oct 22 has significant work to do. Next week the battle lines are already drawing up at the Asia-Europe summit in Brussels (and China’s PM Wen and Japan’s PM Kan both travel) and then the annual IMF/G7 meetings in DC. The key US September payrolls report on Friday, for good measure, may be the deciding data set for the Fed to pull the trigger on QEII. And also meeting next Thursday is the Bank of England, itself back in a QE frame of mind if you listened this week to one of its policymakers Adam Posen  

But apart from a sliding dollar and rampaging emerging markets, the most interesting development this week was the steep euro climb in the face of some severe credit/debt/banking scares in Dublin and even Lisbon. Although the FX market focus is clearly on the Fed and interest rate differentials (rate futures are showing a yawning gap between US and euro zone interest rates over the next year or two) the euro rise a remarkable turnaround from the Spring  when every sovereign debt wobble led to existential euro lunges.

One reason for the shift is credibility in the ample EFSF rescue fund (now AAA-rated) and its ability to cope with any fallout from nasty but relatively containable debt problems like Ireland’s. The other is that the main source of sovereign debt contagion – the impact on other creditor euro zone banks – is has been dampened since the recent EU stress tests allowed local regulators to identify and isolate (and possibly merge etc?) the most exposed banks. And finally, the aggregate euro zone economic, employment and credit data remains surprisingly strong through Q3 and the ECB seems able to continue to gradually withdraw excess liquidity – in stark contrast to the Fed. The ECB meeting next Thursday will be an important sounding on its intentions going forward.