A lack of activity by the U.S. Federal Reserve last Thursday by keeping the interest rates low was not surprising for some people, yet it reassured analysts that other central banks will now be looking to ease their policies even more. This move is expected to be the epicenter of global shock waves across currency markets.
The U.S. Federal Reserve cited concerns over the global economy and financial market volatility among the factors that played a role in keeping interest rates near zero.
The Fed hoped that its decision to not alter interest rates would help soothe frayed nerves at home and overseas, but that does not seem to be the case.
Global Markets Lower as “Currency Wars” Threat Looms
While a delay in a rate rise on paper should help support risk assets, global markets were noticeably lower after Fed Chair Janet Yellen’s statement, which did little to offset investor uncertainty or encourage on the health of the domestic U.S. economy.
“However, any bounce in risk assets will be short-lived,” said Kit Juckes, macro strategist at Societe Generale. He also added that in currency markets, the Japanese Yen “could be the biggest winner” if the risk mood sours.
One of many ripple effects that are expected from this move is the increase in severity of global currency wars. Valentin Marinov, managing director and head of G10 FX research at Credit Agricole, commented on Friday that he expects global “currency wars” to intensify from here.
He predicts the Bank of Japan (BOJ), the European Central Bank (ECB) and the People’s Bank of China (PBOC) have now effectively been pushed into unveiling more stimuli.
“The Fed inaction could spur other central banks into action,” he said. “It is currency wars.”
The dollar slipped to a three-week low against a handful of major currencies after Thursday’s decision. This comes after the greenback had been appreciating significantly since the middle of last year in anticipation of higher interest rates in the U.S.
A higher interest rate can mean a higher yield on assets and investors in the U.S. have been busy bringing their dollars home, and thus out of high-yielding foreign investments.
How Will Emerging Markets React to the Fed?
A weaker dollar in the short term could now leave other global economies frustrated and dent export-focused companies that favor a weak domestic currency.
There are several other ways in which a country can deal with fluctuations in its currency. Manipulating reserve levels is one of the ways that a country’s central bank can intervene against currency fluctuations. Other measures include altering benchmark interest rates and quantitative easing (QE).
Central banks often stress that exchange rates are not a primary policy goal and can be seen more as a positive by-product of monetary easing.
There have been discussions over the last few years about countries purposefully debasing their own currencies — a concern that was termed “currency wars” by Brazil’s Finance Minister Guido Mantega in September 2010.
Credit Agricole’s Marinov highlighted that the ECB could be the next to act by ramping up its current bond-buying program, thus weakening the single currency – even though its only mandate is to manage inflation.
Analysts at BNP Paribas also stated Friday that the Fed decision had increased their conviction that the ECB would increase its quantitative easing program. Marc Ostwald, strategist at ADM ISI, said in a note Friday that the ECB and the BoJ who will now face “even bigger challenges, given that the Fed is clearly not in any hurry to live up to its part of the ‘policy divergence’ grand bargain.”
But there’s also the volatility coming from China. Growth concerns in the world’s second-largest economy have spiked in recent weeks after the country’s central bank decided to intervene and weaken the Chinese Yen. This managed to roil global stock markets with the Shanghai Composite losing its year-to-date gains.
Chinese authorities might want a change to a more consumption-led economy, but this devaluation proved to many that they are not scared of helping out their export-focused sector. And Marinov highlighted that a weaker dollar could now mean Beijing could devalue the yuan further as it looks to deleverage its economy.
“(This) could unnerve and indeed lead to more market turmoil,” he said. “So by implication the Fed might be seeing more risks to their lift off.”