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Abstract:With no indication that governments are willing to work together, nations are being forced to forge ahead on their own in creating defenses against the inexorable strength of the almighty dollar.
With no indication that governments are willing to work together, nations are being forced to forge ahead on their own in creating defenses against the inexorable strength of the almighty dollar.
The US dollar is strengthening steadily against all of its counterparts by the most in decades, supported by the Federal Reserve's hawkish policy, the US economy's strength, and investors looking for safety from market gyrations. Japan has joined countries like Chile and India that have been using their dollar reserves to combat the powerful dollar as the most recent major nation to enter the foreign exchange fray.
The current currency market issues are similar to those of the 1980s in many ways, but it is unlikely that the remedies will be. The Plaza Accord, which was reached in 1985, was the result of an agreement between the world's economic giants to address the issue of the dollar's continued strength as a unit. With national economic interests diverging and the multi-decade shift toward deeper global integration being pushed into reverse, there is no indication that such a treaty would materialize this time.
The US government would need to participate in coordination along the lines of a new Plaza Accord, and according to strategist Viraj Patel of Vanda Research, there is “close to 0% probability on the Treasury intervening right now to weaken the dollar.” There is a ton of literature that demonstrates that trying to “lean against the wind” in the foreign exchange market when monetary policy is having the opposite effect is pointless.
An official from the US Treasury confirmed that it did not take part in the action that Japan took on Thursday, and the European Central Bank stated that it did not participate in currency market interventions. According to a spokesperson, the US Treasury was aware of the action but refrained from endorsing it.
The world's already-increasing inflationary pressures are being fueled by the weakening of everything from the euro to the South Korean won, prompting many policymakers to go deeply into their toolbox.
With stronger-than-expected FX fixes, China, the second-largest economy in the world, is continuing to construct its own defense against the dollar. To combat growing consumer prices and currency devaluation, central banks from most of the world, with the exception of Japan, are raising interest rates.
This week, after the US central bank reaffirmed its intention to raise borrowing costs in an effort to combat inflation, the Bloomberg dollar index, which compares the dollar to a basket of equivalents from both emerging and developed markets, reached new highs.
The Japanese government was clearly unable to cope with the broad-based dollar strength and the market repercussions of the most recent Bank of Japan decision. Tokyo officials had previously only expressed concerns about the FX market, but on Thursday they stepped up their battle by taking active action to support the yen for the first time in decades. This is true even as its central bank continued to hold the line on maintaining low official borrowing costs, defying the global trend toward tightening monetary policy.
Japan now joins a growing list of nations, including Chile, Ghana, South Korea, and India, that have intervened directly in foreign exchange markets. At its policy meeting on Thursday, Switzerland's central bank declared its readiness to act in the foreign exchange market as needed.
The world is currently much more fragmented than it was in the 1980s, according to George Boubouras, head of research at hedge fund K2 Asset Management and a veteran of the markets for three decades. The likelihood of international cooperation to weaken the dollar is almost zero; anticipate more reversal currency wars.
The size of FX trading today, which reached an average daily turnover of $6.6 trillion during the most recent triennial study performed by the Bank for International Settlements back in 2019, is a significant departure from the 1980s. This is a significant increase from the $5.1 trillion it was just three years prior and far more than it was in 1986, when the BIS first started compiling this type of activity survey.
damage limitation
From Tokyo to Santiago, policymakers are almost constantly putting out fires in an effort to lessen the harm the US dollar is doing to their economies. Its rise has already increased the price of food imports globally, precipitated Sri Lanka's unprecedented debt default, and increased losses for bond and stock investors worldwide. And practically every other currency will continue to be under pressure as long as the Fed is increasing borrowing costs more quickly than its rivals.
Additionally, it is exacerbated a problem with inflation whose roots were planted during the pandemic supply-chain issue and Russia's conflict in Ukraine. The rise in the value of the dollar this year has already increased the price of food imports globally, precipitated a historic debt in Sri Lanka, and compounded losses for bond and stock investors.
The majority of foreign currencies will continue to be under pressure, though, as long as the Fed continues increasing borrowing costs more quickly than most rivals.
Japan is determined to keep its ultra-dovish monetary policy in place, unlike in the 1980s. At a briefing on Thursday, BOJ Governor Haruhiko Kuroda insisted that no rate increases were planned and that the current direction of future policy would not change, even in theory, for another two or three years. And even though it has more firepower in its reserves than it did the last time it moved to prop up the yen, the direct intervention might ultimately amount to little more than a rearguard action.
Jeremy Stretch, head of Group-of-10 currency strategy at Canadian Imperial Bank of Commerce in London, stated that Japan's government “can just slow the decline, until the dollar impulse wanes or Japanese trade dynamics turn,” indicating that he was not a believer in a redo of the Plaza Accord.
The energy crisis and the conflict in Ukraine are battering the European Union's economy, making it more difficult for the European Central Bank to follow the Fed's path of rate increases.
Market participants claim that there are further fundamental reasons why a worldwide agreement to reverse the strength of the dollar is wishful thinking.
To begin with, China is now the US, Japan, and nations in Europe's largest trading partners. While the yuan is under pressure against the dollar and the Chinese government is attempting to counteract weakness with its fixes, the situation is far from troubled levels that would necessitate Beijing's assistance. Without Beijing's participation, an agreement is likely to be unsuccessful. Given that the dollar's strength is clearly at play, the yuan is currently trading close to historical highs against some of its key Asian rivals.
What's more, there is a startling lack of US backing to stop the dollar's rise.
At recent congressional hearings with Powell and Treasury Secretary Janet Yellen, the dollar's strength hardly merited mentions. In reality, the strength of the dollar makes it easier to resist pressures on consumer prices because it lowers the cost of imports while also perhaps impeding economic development.
Jane Foley, a strategist at Rabobank in London, said: “I don't think a Plaza-type pact is likely, at least not until the Fed believes that it has broken the back of the inflationary danger in the US.” “Dollar strength is a by-product of its tight monetary policy, and measures to weaken the greenback would be in conflict with its interest-rate and quantitative-tightening policies,” the author writes.
Backing off
Policymakers have little choice but to continue defending their currencies or risk significant economic hardship, despite the possibility that combating the dollar's dominance without US assistance will ultimately prove fruitless.
To protect the city's currency peg, Hong Kong's monetary authority has purchased local currency at a record rate. Chile's central bank launched a $25 billion intervention plan in July.
It costs emerging economies collectively more than $2 billion in foreign reserves each everyday to defend their currencies against the dollar, and strategists expect efforts to increase.
Rate increases will simply have to be made, according to Lutz Roehmeyer, chief investment officer at Berlin-based Capitulum Asset Management, until no one is speculating against the country's currency any longer.
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