Column: The Upside Down World of “Reverse Currency Wars” Is Real: Mike Dolan


Euro, Hong Kong dollar, U.S. dollar, Japanese yen, pound and Chinese 100 yuan banknotes are seen in this illustration, in Beijing, China January 21, 2016. REUTERS/Jason Lee

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LONDON, June 22 (Reuters) – A topsy-turvy world of “reverse currency wars” is seeping into the real world.

Netflix enthusiasts hitting “Stranger Things” know well how the chaos and monsters of the show’s eerie parallel universe seep into everyday life, to devastating effect. Read more

Something similar seems to be happening for one of the dominant economic policy tropes of the past decade.

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Financial firms, such as Goldman Sachs, have warned for months that long-running “currency wars” – where countries struggle to keep a weakened US dollar and overvalued national currencies from crimping exports – could be reversed, with frightening consequences.

Dubbing this twilight political zone “reverse currency wars”, they believe that the re-emergence of inflation, a hawkish Fed and the strength of the dollar would force governments and central banks to rethink the direction of exchange rates and to rush to keep up.

In the decade since the US Federal Reserve launched quantitative easing bond buying to stave off deflation, many countries have complained that the resulting dollar weakness will hurt their trade in a low-growth world and force them to overheat trying to match the Fed’s ease. silver.

But that all changed after the Fed’s aggressive turn this year to rein in 40-year high inflation with significantly higher interest rates, a halt to new asset purchases and a planned reduction in its balance sheet. inflated by over $8 trillion.

The result has been a surge in the dollar which has seen its index against other major currencies soar nearly 20% over the past year – leaving US trading partners with the opposite problem of trying to support instead than capping currencies lest their weakness make the price of the dollar for energy and food imports even more expensive, aggravating skyrocketing inflation everywhere.

Over the past week, “reverse currency wars” have become a reality.

The turnaround was most evident in the Swiss National Bank’s sharp interest rate hike on Thursday, an apparent shift in its overall policy from suppressing the Swiss franc to fend off deflation to adopting its strength as a tool to calm imported inflation. Given that its permanent policy has led it to accumulate more than $1 trillion in foreign exchange reserves, the change is potentially seismic. Read more

“This move confirms our bullish view on the franc and is the strongest evidence yet of our ‘reverse currency war’ thesis – the era of targeting weaker exchange rates is over,” said Goldman’s foreign exchange team to clients, adding that the analysis showed a 1% franc rise of 0.1/0.2 inflation points and saying that the SNB would likely seek a 5% hike in the rate of real exchange of the franc.

Dollar percentage gains over the past year
G4 inflation rate since 2000

“DEEPLY DISTURBING”

But it’s not the only one. This week, Bank of England policymakers made it clear they were also debating this upside-down world, nervously watching the pound’s 14% fall against the dollar in just 12 months and a decline of 5% of the trade-weighted pound this year alone.

On Monday, BoE rates chief Catherine Mann said one of the reasons she voted for a half-point interest rate hike last week rather than a quarter point was to prevent “imported inflation via a depreciation of the pound”. Read more

Although fellow BoE chief economist Huw Pill on Tuesday downplayed the importance of explicit targeting or “adjustment” of the pound – taboo in Britain since the pound was expelled of the European exchange rate mechanism 30 years ago – the cat seems to be irrelevant bag. The pound is surely a major factor.

An increasingly belligerent European Central Bank also faces record inflation in the eurozone, exaggerated by blinding energy price hikes and a nearly 15% fall in the euro against the dollar during of the past year.

Just last month, Banque de France Managing Director Francois Villeroy de Galhau warned of excessive euro weakness, saying: “A euro that is too weak would run counter to our objective of stable price. Read more

Japan is in a bigger mess. He talks almost daily about the excessive weakness of the yen – now at a 24-year low against the dollar – even as the Bank of Japan persists with a policy of capping government borrowing rates via billions of dollars in bond purchases in the face of creeping inflation and rising yields around the world.

It’s hard to say how long Tokyo can go on with the latter while worrying about the former.

Emerging economies – many of which face far more destabilizing food and energy price inflation – have already tried to preempt Fed tightening over the past year. But greater dollar strength could force them to tighten the screws even more at a dangerous time.

The big risk in the eyes of many people is that the Fed’s promise of an “unconditional” war on inflation will put ever-increasing pressure on the dollar in a world where surges in dollar-priced commodities are entrenching inflation expectations everywhere and force everyone else to imitate the US central. bank, for better or for worse. Read more

Citi strategist Ebrahim Rahbari says all of this points to “excessive tightening” around the world – a “deeply worrying” prospect for global markets, with stocks lower, bond yield curves flatter and a steep squeeze financial conditions.

“Reverse currency wars are strongly bearish for risk assets,” he said, adding that the currencies of the most dovish central banks and fragile economies are the most vulnerable.

If such a crisis accelerates a global slowdown, there may well be strong pressure on the Fed to back down. But war-induced energy problems, tight post-pandemic labor markets and political pressures ahead of the U.S. congressional midterm elections in November argue against any easing this year.

The upside down world seems here to stay.

Main central bank interest rates since 2000
Emerging market central bank rates since 200

The author is Finance and Markets Editor at Reuters News. All opinions expressed here are his own.

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by Mike Dolan, editing by Tomasz Janowski Twitter: @ReutersMikeD

Our standards: The Thomson Reuters Trust Principles.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and non-partisanship by principles of trust.

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