FX Outlook. Race to the bottom

Transcription

1 Financial Markets Research Marketing Communication Jane Foley Race to the bottom Senior FX Strategist +44 (0) jane.foley@rabobank.com Disinflation and near-zero interest rates.....suggest that many central banks will be looking for softer currencies. We look at the winners and loser in the race to the bottom so far within the G10 Currency an increasingly important variable for central banks? For a number of monetary authorities faced with interest rates close to or at zero, the value of the currency has become an increasingly important variable in determining monetary conditions. The SNB, the RBA and the RBNZ are among those developed world central banks whose actions or words openly validate this view. Others such as the ECB and BoJ are far less candid on issues related to the exchange rate although by following extremely accommodative policies both of these central banks have achieved an easing in monetary policy conditions via the exchange rate in recent months. In view of the creep of disinflationary pressure it is likely that many central banks will continue to welcome depreciating currencies in That said, since not all currencies can weaken simultaneously, there will be winners and losers in this race to the bottom. In this report we look at the behaviour of developed world currencies since 2007, the year which marked the start of the financial crisis. Based on a simple framework of growth and inflation we look at which countries have benefitted most from exchange rate weakness since the crisis years and at those which may be most deserving of a softer currency now. The results are not necessarily consistent with the estimates of fair value which are implied by Purchasing Power Parity. Chart 1: Developed world effective exchange rate indices (BOE) rebased to 2007 (see table) Page 1 of 8

2 In many developed world countries the role of exchange rate policy does not fall under the mandate of the central bank but the Treasury. This is the case in both the US and Japan. It explains why in some nations central bank officials avoid commenting directly about the exchange rate. In the mid-1990s, the US Treasury extolled the virtues of a strong dollar. This, however, is clearly not appropriate in a low inflationary environment and so this policy has been brushed under the White House carpet. In Japan, the Ministry of Finance is responsible for setting yen policy. Speaking to reporters in Tokyo on September 4, BoJ Governor Kuroda talked of a virtuous cycle in Japan s economy that wouldn t be derailed by a weaker yen. This was the closest a BoJ official is likely to get to signaling which direction is preferred for the yen. Also in September Bank of Canada Governor Poloz explained his views on currency. Rather than provide direction, however, he explained why he would not. He remarked that "a floating loon is a thing of beauty, and so is a floating loonie, at least from this economist's perspective." Effective exchange rates: most to least appreciation from 1/1/07 to various end dates Nov 2014 Nov 2013 Nov 2012 Nov 2011 Nov 2010 Nov 2009 Nov 2008, BoE Switz Switz Jpn Jpn Jpn Jpn Jpn Aus Jpn Switz Switz Switz EZ Switz NZ Aus Aus Aus Can Switz EZ Jpn Can Can Can Aus Can US Can NZ Nor Nor Nor Aud Can US Swed Swed Swed EZ Nor Nor EZ Nor NZ EZ Swed NZ Swed Swed EZ EZ NZ NZ Swed Aus Nor US US US US US NZ UK UK UK UK UK UK UK Verbal intervention or keep schtum? For central banks that are prevented by their mandates or ideals from participating in verbal intervention in the currency market they can be put in a disadvantage insofar as one potential policy tool is unavailable. Other central banks make no attempt to tip-toe around the issue of currency value. The Norges Bank makes little effort to veil the importance of the value of the import weighted krone on policy settings while both the RBA and the RBNZ have been actively talking down the value of their respective currencies this year. In addition, the RBNZ has intervened in the FX market as recently as August 2014 to undermine the strength of NZD/USD, in November 2014 the RBA talked about the possibility of intervention while the SNB blatantly maintains a EUR/CHF floor. Chart 2: CPI indices (OECD) rebased to 1/1/2007 Chart 3: CPI indices (OECD) rebased to 1/1/2013 Page 2 of 8

3 Swiss effective exchange up most since 2007 The SNB put its currency floor in place in September 2011 and it is not difficult to understand the reasoning behind this draconian measure. Chart 1 shows the values of the effective exchange rates of developed world currencies rebased against the US effective exchange rate at the start of 2007 (BoE data are used). The chart shows that over the course of this period, the Swiss effective exchange rate has appreciated the most. Up until late 2012, the Japanese effective exchange rate had appreciated more but since then the value of the yen has weakened substantially. Chart 2 shows CPI inflation indices rebased to the US CPI from the same period. (OECD data are used to ensure consistency between the various inflation indices.) These data show that the two countries (Switzerland and Japan) which have suffered most exchange rate strength have also seen the least inflation over the period under review. Interestingly, the charts also show that the UK is the country which has seen the least exchange rate appreciation measured since the start of Correspondingly, the UK has also seen the greatest rise in its inflation index though this was boosted by a rise in VAT in January Chart 4: GDP indices (OECD) rebased to 1/1/2007 Chart 5: GDP indices (OECD) rebased to 1/1/2013 The relative weakness in the UK s effective exchange rate measured since the start of 2007 may suggest that it has been the most successful player in the currency wars within this group. This conclusion, however, is not necessarily borne out by GDP data (chart 4). Measured since the start of 2007, UK GDP growth has been the third poorest performer after the Eurozone and Japan. The countries which have seen the most expansion in GDP over this period are Australia and New Zealand. These countries are at second and third place in the inflation table even though their respective effective exchange rates have been relatively strong across the period under review. The combination of strong growth and inflation should have a causal link to the value of the exchange rate, so in this context Australia and New Zealand conform to text book theory. The relative strength of the Australian and New Zealand economies over the period under review may imply that the aggressive verbal intervention that has been implemented fairly aggressively by both the RBNZ and RBA in recent months is not fully justified. That said, looking at trends that extend across a long period can be misleading. What happened to growth and inflation in 2007 is now less relative for a central bank s current policy preferences. However, if the same data is rebased to the start of 2013 Australia and New Zealand still fare well in terms of growth. What is noteworthy in this horizon is that the UK also scores well. Even though the UK performed reasonably poorly in terms of economic expansion across the period since 2007, measured since the beginning of last year, the trajectory of growth in the UK has clearly steepened. It has outpaced that of New Zealand (where interest rates have been hiked four times to contain inflation) and matched that of Australia. It is quite possible that if all Q3 data were available that the pace of UK growth measured over this shortened period Page 3 of 8

4 will have topped the table. In tandem with the better performance of growth, the UK s effective exchange rate has also strengthened; it is behind only the US and New Zealand over this timeframe. Japan has had success in weakening its currency recently In the shortened timeframe (since January 2013) it is Japan that has had most success in weakening its currency on the back on both Abenomics and a massive stimulus package by the BoJ. Interestingly, over this period Japan has also seen the greatest appreciation in its inflation index, though this has been boosted by the 3% hike in the consumption tax in April Chart 5 shows quite clearly the impact that this tax hike has had on growth. Clearly Japan s economy is still very vulnerable and it is not difficult to understand why the BoJ s Kuroda doesn t believe that Japan s economic improvement would not be de-railed by the weaker yen. Chart 6: Developed world effective exchange rate indices (BOE) rebased to 2013 The most shallow improvement in GDP over the shortened time frame has been seen in the Eurozone. Its inflation index has also been correspondingly slack though not in the deflationary territory that Sweden and Switzerland have found themselves. The weak growth and inflation backdrop in the Eurozone cries out for exchange rate weakness. However, in the period since the start of last year, the pace of appreciation of the Eurozone s effective exchange rate is fourth from the top of the table. Although the EUR has been softening in 2014, the ECB has not (yet) scored highly in the currency war. This, however, is changing. It seems very likely that by following aggressive policy easing and threatening to embark on full blown QE the ECB is hoping to push the EUR to weaker levels. The current loser in the currency war is the US. Its effective exchange rate is at the top of the table over the shortened time frame (since January 2013). Although the harsh winter in Q provided a setback to US growth, the trajectory of its GDP index in subsequent quarters has steepened more than all of its peers. That said, the trajectory of its CPI index has flattened out and this could imply that the gains in the value of the USD could be unwelcome to the Fed. This has the potential of keeping the Fed dovish for longer and could have some bearing on the timing of the first Fed interest rate hike. EZ is the perhaps most deserving of a weaker currency next year, or is it? Depending on which time-horizons are considered, these data show that the UK and Japan have had some success in currency wars. Very recently the oil related effective exchange rates of Norway and Canada are showing signs of slippage and so too is the Swedish rate. In view of its battle with deflation, the Riksbank has cut interest Page 4 of 8

5 rates aggressively in recent months and there is talk that in 2015 it could pursue more extraordinary policy measures such as QE or a currency floor. The Riksbank could thus become more aggressive player in the race to the bottom during 2015, though this is unlikely to be necessary if the exchange rate retains its current softer stance. Looking ahead the ECB can arguably draw most justification for pressuring its currency from its poor growth trajectory and by the coincident low level of inflation. Persistent deflation in Switzerland suggests that the SNB will continue to actively pursue measures to keep its currency from appreciating. Purchasing power parity estimates of fair value support the continued use of aggressive methods by the SNB to prevent further exchange rate appreciation. The OECD PPP model suggests that the CHF is 31% overvalued relative to the USD. The same model, however, provides dramatically different implications for other central banks. Although the growth and inflation charts above support the need for weaker currencies in Japan and the Eurozone, PPP suggests that the ECB and the BoJ have little reason to push their currencies lower. Fair value for EUR/USD is close to current values, while the JPY is now 13% undervalued vs. the USD. That said, PPP does suggest that USD is undervalued vs. all other developed world currencies a factor which is likely to support the momentum behind the next phase of currency wars. Page 5 of 8

6 Rabobank FX Forecasts USD Crosses 21-Nov 1m 3m 6m 9m 12m JPY EUR GBP CHF AUD NZD CAD SEK NOK CNY ZAR MXN BRL INR TRY EUR Crosses 21-Nov 1m 3m 6m 9m 12m JPY GBP CHF SEK NOK AUD CAD NZD PLN CZK HUF BRL GBP Crosses 21-Nov 1m 3m 6m 9m 12m EUR JPY CHF AUD NZD CAD Page 6 of 8

7 Financial Markets Research Head Jan Lambregts Macro Elwin de Groot EMU Emile Cardon EMU, Switzerland Bas van Geffen EMU Philip Marey US Michael Every Asia Jane Foley UK Foreign exchange Jane Foley G Christian Lawrence LatAm Piotr Matys CEE Fixed income Richard McGuire Lyn Graham-Taylor Matt Cairns SSA Credit markets Eddie Clarke Corporates Stephen Queah Corporates Oliver Burrows Financials Ruben van Leeuwen ABS, Covered Bonds Agri Commodity markets Food & Agribusiness Research and Advisory (FAR) Tracey Allen Client coverage Wholesale Corporate Clients Martijn Sorber Global Head Hans Deusing Netherlands David Kane Europe Brandon Ma Asia Neil Williamson North America Enzo Folch South America Sergio Nakashima Brazil Financial Institutions Eddie Villiers Global Head Arjan Brons Benelux Krishna Nayak Germany, Austria, CEE Emmanuel Rodriguez Iberia Philippe Macart France, Italy Simon Jansen Treasury Sales Europe David Pye Central Banks Capital Markets Rob Eilering ECM Rob. Mark van Binsbergen DCM Herald Top DCM Othmar ter Waarbeek DCM Page 7 of 8

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