July - No. Continuously excessive exchangerate fluctuations In this Flash, we will look at the currencies of major OECD countries (dollar, euro, yen, pound sterling, Swiss franc, Australian dollar) and emerging currencies taken as a whole. At different periods, new mechanisms appear that lead to excessive fluctuations in exchange rates, for different reasons: before the crisis (-, first half of ), carry trades financed with low interest-rate currencies (yen, Swiss franc) and invested in higher-interest rate currencies (pound sterling, Australian dollar, emerging currencies, euro); in a first phase of the crisis (second half of, first half of ), firstly a flight from the dollar as the crisis broke out in the, and a switch into emerging currencies (due to the decoupling theory) and into the euro; appreciation of the yen and the Swiss franc, depreciation of the pound sterling and the Australian dollar due to the end of carry trading; in a second phase of the crisis (second half of, first quarter of ), safe haven role of the dollar, significant aversion for emerging risk, fall in commodity prices: the dollar appreciated; emerging currencies and the Australian dollar depreciated; the pound remained weak and the yen and the Swiss franc strong; since April, rise in confidence again and prospect of an improvement in the economy; renewed investment in the currencies of countries where the markets believe growth will return faster: emerging countries, Australia, United Kingdom. ECONOMIC RESEARCH Author: Patrick Artus The "stories" told in the markets to justify the currency fluctuations are sometimes far-fetched: there was no reason to doubt that growth would return in most emerging countries, the United Kingdom remains in a tricky situation. However, we can see the huge exchange-rate fluctuations fuelled by the masses of capital shifted around, according to the markets perception. These fluctuations are unacceptable for the countries real economies, and are threatening global economic and trade integration.
Huge exchange-rate fluctuations since the middle of this decade For several years, we have witnessed drastic exchange-rate fluctuations (Charts A, B, C and D): depreciation of the dollar until the summer of, followed by a marked appreciation; sharp appreciation of the yen since the summer of ; depreciation of the pound sterling since the summer of ; appreciation ( - summer ), and then a depreciation of the Australian dollar and emerging currencies; appreciation of the Swiss franc since the summer of. Chart A Exchange rates JPY/USD (LH scale) USD/EUR (RH scale)..... GBP/USD GBP/EUR Chart B Exchange rates.............. Chart C Exchange rates against the dollar Chart D CHF/EUR exchange rate.......... Australian dollar/usd (LH scale) Currencies of emerging count ries/ USD (: =, RH scale)............... These exchange-rate fluctuations stem from changes in investor beliefs and perceptions. We can identify four phases. Four phases in investor attitude towards exchange rates Phase : - summer Before the crisis, capital flows in foreign currencies were dominated by carry trades between low interest-rate currencies (yen, Swiss franc, Charts A and B), because they are the currencies of countries with chronically low inflation, and higher interest-rate currencies (pound sterling, Australian dollar, emerging currencies, euro, Charts C and D), because they are the currencies of countries where monetary policy is structurally more restrictive (higher growth, inflation targeting, etc.). Flash - -
Chart A -month interest rate. Chart B Sw itzerland: -month interest rate. Japan.......... Euro zo ne United Kingdom Australia Chart C -month interest rate Chart D Emerging countries as a whole: -month interest rate When looking at the open positions in the respective currencies (Charts A, B and C), we can clearly see the loans in Swiss francs and yen until the summer of, the investments in dollars since the summer of, the investments in pound sterling in -, then the short position in sterling, and the investments in euros and Australian dollars in -. The dollar did not benefit from these carry trades financed in low interest-rate currencies because of the concern fuelled by the widening US trade deficit (Chart ). Flash - -
Chart A Net open positions in Sw iss francs and yen (', number of contracts) Net open positions in CHF Net open positions in JPY Chart B Net open positions in dollar and pound sterling (', number of contracts) Net open positions in USD Net open positions in GBP - - - - - Sources: Bloomberg, Datastream, Natixis - - - - - - - Chart C Net open positions in euro and Australian dollar (', number of contracts) Net open positions in EUR Net open positions in Australian dollar Chart : Nominal trade-weighted exchange rate and trade balance Nominal t rade-weighted exchange rat e (: =, LH scale) US t rade balance (USD bn per year, RH scale) - - - - - (*) Rise = nominal appreciation - - - - - -, Phase : Second half of - first half of This was the first part of the crisis: risk aversion increased (Chart ), but it was still believed that it was an Anglo-Saxon finance crisis in the and the United Kingdom. The theory of decoupling was adopted: there was a belief that growth would remain brisk in emerging countries, and this also accounted for the increase in commodity prices and the rise in emerging-country equities in this period (Charts A and B). Chart Natixis risk perception index............ Flash - -
Chart A Emerging countries as a whole: Stock market index (: = ) Chart B Spot commodity prices in dollars (: = ) Oil Non-precious metals Food Increased risk aversion meant the end of carry trades. In a manner consistent with these financial market perceptions, we witnessed (see Charts A to D above): depreciation of the dollar and pound sterling; appreciation of the euro, emerging currencies, and the Australian dollar; appreciation of the yen and the Swiss franc due to the end of carry trades. Phase : Acute phase of the crisis in the aftermath of the Lehman debacle (second half of, first quarter of ) Risk aversion became extremely high (Chart above) and the crisis became global; it affected emerging countries (Chart ) and commodity prices (Chart B). The dollar played the role of a safe haven, and carry trading obviously did not pick up again. Chart Manufacturing output (Y/Y as %) - - - EU- Japan Emerging countries as a whole - - - - - The results were: renewed appreciation of the dollar; continued strong yen and Swiss franc ; weakening of all other currencies: pound sterling, Australian dollar, euro, emerging currencies. Flash - -
Phase : Since April Since April, some signs of improvement in the economies have appeared (Chart ) and commodity prices have picked up again (Chart B). Chart Manufacturing PMI Euro zo ne United Kingdom Emerging countries as a whole including Russia So financial markets are again investing in the currencies of countries believed to be candidates for a faster economic upturn than others: emerging countries, United Kingdom, Australia (commodity-producing countries). This has led to: a (minor) weakening of the dollar (against the euro); an upturn in pound sterling, emerging currencies and the Australian dollar. The yen and the Swiss franc have not fluctuated and have remained strong (despite foreign exchange interventions in Switzerland), because financial markets still do not use debt leverage and because all currencies now enjoy very low interest rates (Charts A and B above). Conclusion: These currency fluctuations are unbearable for the real economies, and are due to the magnitude of capital flows In each era, financial markets make an assessment and form an opinion, and sometimes spin fairy tales. For example, the mistrust towards emerging countries at end- and early was excessive as very soon after, growth picked up again in many of these countries (firstly, China, India, Russia, etc.). Another example was the optimism surrounding the United Kingdom in the spring of, which was completely excessive given the contraction in the finance sector, falling asset prices, etc. The problem is that when financial markets change their beliefs, the result is huge capital flows - as we have seen in the case of emerging countries (Chart ) - which destabilise real exchange rates (Charts A and B). The pace at which real exchange rates fluctuate is so rapid that it is impossible to correct by real economies. We have seen for instance the collapse in Japanese exports due to the yen s real appreciation (Chart ). Flash - -
Chart Monthly capital flows of emerging countries as a w hole* (incl. Russia and OPEC, in USD bn per month) Chart A Real trade-w eighted exchange rate (: = *) Euro zo ne United Kingdom - - (*) = M ont h-on-month change in off icial reserves - trade balance for the month - - (*) Rise = real appreciation of the exchange rate - - - - Chart B Real trade-w eighted exchange rate (: = *) Emerging countries as a whole Australia Japan Chart Exchange rate and exports in value terms (local currency, Y/Y as %) JPY/USD (LH scale) Japanese exports (RH scale) Global exports (RH scale) (*) Rise = real appreciation of the exchange rate - - - Flash - -