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10.04.2016 20:10 -
How low can the US dollar go? Lower than you think
The Fed does not have the delegated authority to determine exchange rate policy
Markets think there is a zero probability that the Fed will hike rates this month
The Bank of Japan does not have the authority to decide exchange rates either
The BoJ will holds its next monetary policy meeting on April 28
Markets will test the Ministry of Finance’s “pain threshold” on USDJPY until then
Neither the Federal Reserve nor the Bank of Japan have delegated authority to determine exchange rate policy. Rather, that is the preserve of the US Treasury Department and Japan’s Ministry of Finance respectively. As such, intervention in the currency markets would be as much a political decision as a market call, especially given sensitivity over the issue of “currency wars”.
Nobody expects the US Treasury to authorise the Fed to sell the US dollar, even though the Federal Open Market Committee is clearly concerned that the relentless rise in the dollar over the last couple of years is hindering attainment of its inflation target. “Earlier dollar appreciation is still expected to weigh on consumer prices in the coming months” said Committee chair Janet Yellen in her monetary policy speech on March 29. “I continue to expect that overall PCE inflation for 2016 as a whole will come in well below 2%”. She expects inflation to move up to target in the following two years “assuming no further swings in energy prices or the dollar”.
Clearly then, the Fed’s tolerance for a rising dollar in the next few months is low. The markets are aware there is little chance of intervention in the currency market; instead the forward interest rate curve is being lowered quite sharply in the belief the Fed will delay the next rate rise until the dollar has stabilised, or preferably declined.
Since the FOMC first raised its policy rate at the December meeting, Yellen has been at pains to emphasis that every subsequent meeting is “live” as far as the next move up is concerned (although notably she did not repeat the warning it in her recent speech) and yesterday’s March meeting minutes suggested some appetite for a move when the FOMC next convenes on April 26-27. But markets are adept at separating rhetoric from reality, and as of today an April hike is assigned a zero probability. In fact one is not fully priced in until August 2017.
цитирайMarkets think there is a zero probability that the Fed will hike rates this month
The Bank of Japan does not have the authority to decide exchange rates either
The BoJ will holds its next monetary policy meeting on April 28
Markets will test the Ministry of Finance’s “pain threshold” on USDJPY until then
Neither the Federal Reserve nor the Bank of Japan have delegated authority to determine exchange rate policy. Rather, that is the preserve of the US Treasury Department and Japan’s Ministry of Finance respectively. As such, intervention in the currency markets would be as much a political decision as a market call, especially given sensitivity over the issue of “currency wars”.
Nobody expects the US Treasury to authorise the Fed to sell the US dollar, even though the Federal Open Market Committee is clearly concerned that the relentless rise in the dollar over the last couple of years is hindering attainment of its inflation target. “Earlier dollar appreciation is still expected to weigh on consumer prices in the coming months” said Committee chair Janet Yellen in her monetary policy speech on March 29. “I continue to expect that overall PCE inflation for 2016 as a whole will come in well below 2%”. She expects inflation to move up to target in the following two years “assuming no further swings in energy prices or the dollar”.
Clearly then, the Fed’s tolerance for a rising dollar in the next few months is low. The markets are aware there is little chance of intervention in the currency market; instead the forward interest rate curve is being lowered quite sharply in the belief the Fed will delay the next rate rise until the dollar has stabilised, or preferably declined.
Since the FOMC first raised its policy rate at the December meeting, Yellen has been at pains to emphasis that every subsequent meeting is “live” as far as the next move up is concerned (although notably she did not repeat the warning it in her recent speech) and yesterday’s March meeting minutes suggested some appetite for a move when the FOMC next convenes on April 26-27. But markets are adept at separating rhetoric from reality, and as of today an April hike is assigned a zero probability. In fact one is not fully priced in until August 2017.
Watch the right index
So the Fed will be keeping a close watch of the exchange rate, but it won’t be monitoring the widely quoted USD index. Rather it will zero in on the Trade Weighted Index (TWI) shown in the chart below (please click to enlarge).
The obvious difference between the two measures is China. The yuan is not included in the USD index, but it has a 21% weighting in the TWI. And the euro’s 50% plus weighting in the index is way above its TWI weight.
Recent FX market developments suggests the Fed is having some success in containing the dollar by endorsing the the market’s move to lower the forward interest rate curve. The Bank of Japan also thought it could use interest rates to guide the yen lower, or at least stabilise it around ¥120 to the dollar.
No such luck. Perversely, the introduction of negative rates has coincided with a sharp decline in USDJPY, so much so that traders are now on the lookout for signals from Prime Minister Shinzo Abe’s government that they intend to instruct the BoJ to get back into the game of ensuring the level of the exchange rate “reflects the fundamentals” by driving the yen back down. The blue arrows on this chart (click to enlarge) show periods when the BoJ last made a concerted effort to impact the currency.
цитирайSo the Fed will be keeping a close watch of the exchange rate, but it won’t be monitoring the widely quoted USD index. Rather it will zero in on the Trade Weighted Index (TWI) shown in the chart below (please click to enlarge).
The obvious difference between the two measures is China. The yuan is not included in the USD index, but it has a 21% weighting in the TWI. And the euro’s 50% plus weighting in the index is way above its TWI weight.
Recent FX market developments suggests the Fed is having some success in containing the dollar by endorsing the the market’s move to lower the forward interest rate curve. The Bank of Japan also thought it could use interest rates to guide the yen lower, or at least stabilise it around ¥120 to the dollar.
No such luck. Perversely, the introduction of negative rates has coincided with a sharp decline in USDJPY, so much so that traders are now on the lookout for signals from Prime Minister Shinzo Abe’s government that they intend to instruct the BoJ to get back into the game of ensuring the level of the exchange rate “reflects the fundamentals” by driving the yen back down. The blue arrows on this chart (click to enlarge) show periods when the BoJ last made a concerted effort to impact the currency.
BoJ hanging on by the skin of its teeth
The Bank of Japan is scheduled to hold its next monetary policy meeting on April 28, when updated economic forecasts will be presented, including the key inflation projection. In January the CPI (all items less fresh food) was forecast to rise 0.8% in the fiscal year that began last Friday (Apr 1), then onto 1.8% the following year.
However, all we have heard from BoJ Board members lately is that inflation is likely to remain at zero “for the time being”. This suggests the projections will be lowered again in the month-end update, putting pressure on the Board to vote for a further easing of monetary conditions – including a cut in the deposit rate to minus 0.2% at least.
But that’s almost three weeks away and the FX markets are likely to test the Ministry of Finance’s “pain threshold” on USDJPY in the meantime.
And it’s not only the yen that’s in play: EURUSD has defied the odds in recent times. It seems most of the premium built into the US dollar in expectation of “normalisation” of Fed monetary policy is being unwound, with the Fed’s implicit approval. It’s every man for himself now. So how low can the dollar go? A lot lower than you think.
цитирайThe Bank of Japan is scheduled to hold its next monetary policy meeting on April 28, when updated economic forecasts will be presented, including the key inflation projection. In January the CPI (all items less fresh food) was forecast to rise 0.8% in the fiscal year that began last Friday (Apr 1), then onto 1.8% the following year.
However, all we have heard from BoJ Board members lately is that inflation is likely to remain at zero “for the time being”. This suggests the projections will be lowered again in the month-end update, putting pressure on the Board to vote for a further easing of monetary conditions – including a cut in the deposit rate to minus 0.2% at least.
But that’s almost three weeks away and the FX markets are likely to test the Ministry of Finance’s “pain threshold” on USDJPY in the meantime.
And it’s not only the yen that’s in play: EURUSD has defied the odds in recent times. It seems most of the premium built into the US dollar in expectation of “normalisation” of Fed monetary policy is being unwound, with the Fed’s implicit approval. It’s every man for himself now. So how low can the dollar go? A lot lower than you think.
