Unconventional uncertainty. Unconventional monetary policy & model uncertainty in the FX market

Transcription

1 Unconventional monetary policy & model uncertainty in the FX market Michael Metcalfe Head of Macro Strategy Unconventional uncertainty Does the supply of money matter for currencies? The who and when of QE is crucial Do zero rates mean zero FX returns? 1 1

2 Money supply matters Rapid money supply growth usually means a weak currency > Correlation between money supply growth and FX performance > If narrow money supply expands more than 5% the currency halves in value > But how much of this relates to relative inflation or endogenous factors? Annual depreciation vs USD 5% 4% 3% 2% Narrow money supply growth vs FX performance past 2-years 1% HUF KRW CZK NZD ISK CAD GBP % CHF JPN -1% PLN MXN TRY % 1% 2% 3% 4% 5% 6% Average ann. narrow money growth % over the US Average ann. Inflation (PPI) gap 5% 4% 3% 2% 1% % -1% Narrow money supply growth vs relative inflation CZK CHF NZD JPN HUF ISK KRW GBP CAD PLN MXN TRY -1% % 1% 2% 3% 4% 5% 6% Average ann. narrow money growth % over the US 2 Monetary leakages Will extra money leak abroad? > If money printing/asset purchases leak abroad these could weaken the currency > The environment matters, so far deflation means repatriation of equity capital > International bank lending is contracting rapidly US International portfolio investment position Net USD bn JPY UK Debt CAD Equity CHF 12% 8% 4% % -4% -8% US International portfolio investment position % GDP JPY UK Debt CAD Equity CHF 3 2

3 Repatriation questions > Deflation concerns means repatriation has focussed on equity not fixed income capital > This means that the USD not the JPY is a safe haven in spite of quantitative easing > Each week of repatriation is associated with a 1.4% fall in USD 1.6 USD & repatriation 1.6 Explaining USD Feb-8 May-8 Jul-8 Sep-8 Dec-8 Feb Feb-8 May-8 Aug-8 Nov-8 Feb-9 Repatriation Dummy USD USD implied by yield differentials USD implied by yield diff. and repat variable USD 4 Not all printing presses are created equal Motivation matters Printing money to bail out a fiscally irresponsible government Zimbabwe Printing money within the context of an inflation target to combat deflation Japan, UK, US Printing money to weaken your currency Possibility in Japan and Switzerland 5 3

4 Gauging fiscal credibility > QE and an inflation target is a test of credibility > A combination of break even inflation expectations and private investor flows can be used to measure this credibility 5yr breakeven inflation rates Foreign demand for Sovereign bonds, 2d ma Oct-8 Jan-9 US UK JPN (6yr) DEM FRA Oct-8 Dec-8 Feb-9 Bunds Gilts Treasuries JGBs 6 Could QE be a positive (I)? Relative CDS > If printing money makes a default less likely it could be a positive for a currency > Relative CDS spreads have been important drivers for FX markets USD and relative CDS spreads GBP and relative CDS spreads GBP CDS spread above CDS spread USD CDS spread below CDS spread Jan-8 May-8 Sep-8 Jan Jan-8 May-8 Sep-8 Jan-9.7 -USD CDS spread USD rhs GBP- CDS spread GBP rhs 7 4

5 Could QE be a positive (II)? Rate differentials > When rates reach their zero limit it is not necessarily bad for currencies > Changes in yield levels are strongly correlated with currency moves > QE could be positive for GBP wk rolling correlation of currency ret. & yield Av. of 45-developed market pairs Jan- Jan-3 Jan-6 Jan-9 Correlation with changes in yields Correlation with level of yield differentials wk rolling correlation of currency ret. & yield Av. of 9 GBP crosses Jan- Jan-3 Jan-6 Jan-9 Correlation changes Correlation in levels 8 Past experiences with ZIRP > Swiss October April 1979 > Japanese Mar 21- Mar 26 > US 16 th Dec 28 & UK 5 th Mar 29 USDJPY and QE Jan-98 Jan-1 Jan-4 Jan-7 USDJPY (lhs) Japan reserve balance % GDP(rhs) Currency performance (ZIRP day = 1) ZIRP and FX performance CHF (vs DEM) JPY (vs USD) USD (vs ) GBP (vs USD) Days before and after ZIRP 9 5

6 Unconventional uncertainty Does the supply of money matter for currencies? Motivation Context Credibility matters Do zero rates mean zero FX returns ZIRP does not have to be bad for a currency Changes in interest rate differentials matter Reducing model uncertainty Focus on fiscal and inflation credibility Focus on asset mix of net foreign asset position Capture changes as well as level of rate differentials 1 State Street Global Markets is a registered trademark of State Street Corporation used for its financial markets businesses. The products and services outlined herein are offered to professional clients or eligible counterparties through State Street Global Markets International Limited, State Street Bank Europe Limited, State Street Bank and Trust Company, London branch authorised and regulated by the Financial Services Authority (FSA) in the United Kingdom (UK), and State Street Bank GmbH, London branch, authorised by the Bundesbank and German Financial Supervisory Authority (BaFin) and by the FSA; regulated by the FSA for the conduct of UK business, oranother company within the group of companies owned by State Street Corporation Clients should be aware of the risks trading foreign exchange, equities, fixed income or derivative instruments or in investments in non-liquid or emerging markets. Derivatives generally involve leverage and are therefore more volatile than their underlying cash investments. The information provided does not constitute investment advice and is not a solicitation to buy or sell securities. It does not take into account any investor's particular investment objectives, strategies or tax status. All material has been obtained from sources believed to be reliable but we make no representation or warranty as to its accuracy and you should not place any reliance on this information. Past performance is no guarantee of future results. 11 6