Oct. 9, 2010, 11:33 a.m. EDT
Cooperation called for amid ‘currency war’
By Carla Mozee, MarketWatch
LOS ANGELES (MarketWatch) — The so-called “currency war” may see five emerging markets ramp up efforts to curb currency advances, say analysts, as pressure to keep exports competitive overrides official warnings that such interventions could frustrate a flagging global recovery.
The chatter about currency war has grown louder in recent weeks and was a hot topic during the annual meeting of the International Monetary Fund and the World Bank this weekend in Washington. See more about the IMF/World Bank meetings.
“We are seeing so much intervention because countries do not want to lose competitiveness,” said Ousmène Mandeng, a former IMF economist who heads public-sector investment advisory services at Ashmore Investment Management in London.
DXY 77.18, -0.21, -0.27%
The dollar index, year to date.
Central banks that have already intervened to slow currency gains include those in Colombia, South Korea, Peru and Taiwan.
Further actual or verbal intervention efforts are likely to come from the Czech Republic, Poland and South Africa, wrote Arko Sen, analyst with Bank of America/Merrill Lynch’s emerging EMEA group, in a note last week.
Israel, which was also on the list, has said it will continue buying dollars to stem the rise of its shekel.
In a separate Bank of America note, Chile was named as an intervention candidate, as the peso’s valuation was overextended, wrote analyst Alberto Boquin, noting that the peso (U.S.:USDCLP) had gained about 15% in the year to date against the U.S. dollar.
In Chile, President Sebastián Piñera has already said the central bank should clamp down on the peso’s advance. Late Friday, Chile’s finance minister said in Washington that the country won’t impose capital controls to cool the peso’s rise, according a Bloomberg News report.
Intervention by Brazil, whose Finance Minister Guido Mantega asserted the world is in a currency war, has included a doubling of tax, to 4%, on certain foreign investments to curb the rise of its currency, the real (U.S.:USDBRL) . The real rose roughly 6% against the dollar during the third quarter. Gains in the currency cut into Brazilian exports in August.
For emerging markets, any single one doesn’t want to “see their currency become stronger vis-à-vis their main competitors in a third market, say in the U.S. or Europe,” said Mandeng. “They don’t want to be the only one appreciating. And that is a problem.”
Emerging markets “want to stem the flow of hot money and keep their currency stable,” said Mark McCormick, currency strategist at Brown Brothers Harriman.
The intervention environment is ripe, with the Group of 4 economies experiencing weak growth, he said, adding that they are facing fiscal contraction from the expiration of stimulus packages. IMF says developed economies to slow.
At the same time, the Federal Reserve is trying offset those weaknesses by increasing liquidity, with much speculation about the U.S. central bank and so-called quantitative easing.
“And, unfortunately, in an environment when interest rates are zero-bound in most major developed countries,” money from those countries is being borrowed by investors who are then selling it to invest in higher-yielding emerging-market stocks, bonds and currencies, said McCormick.
Meanwhile, quantitative easing by the U.S. central bank is “tantamount to an intervention,” said Mandeng. The Fed’s “printing so many dollars that it effectively changes the relationship between the amount of dollars in circulation and other currencies.”
Outright exchange-rate intervention, monetary policy and capital controls all serve as ways to make it more difficult for investors to access currencies, he said.
Japanese authorities in mid-September intervened in the foreign-exchange market for the first time since 2004, as the greenback (U.S.:USDYEN) hit a fresh 15-year low against the yen — below the ¥83 mark. Earlier this month, the central bank said it will take additional easing measures, including a new temporary fund on its balance sheet to buy various assets. See previous story about Japan’s stimulus efforts.
But market players aren’t just giving into central banks’ desires to cool their currencies. Brazil’s real continued to climb despite twice-daily auctions, and had recently closed at its highest level since just before the collapse of Lehman Brothers, the U.S. financial-services giant, in September 2008.
USDYEN 81.9100, +0.0100, +0.0122%
This year’s price action in the dollar vs. Japan’s yen.
Japan’s yen, meanwhile, has moved below the level of where the central bank intervened on Sept. 15, noted Richard Ross, global technical strategist at Auerbach Grayson.
Intervention, “might work overtime, but in the short term, you can’t stem the tide when it’s that pervasive,” he said.
Peace and cooperation?
The ramped-up intervention worldwide prompted IMF managing director Dominique Strauss-Kahn to warn any currency war would have the effect of reducing cooperation efforts between countries to aid the global economy. Decreased cooperation poses a threat, he said, because “there’s no domestic or national solution to [a] global problem.” Read about Strauss-Kahn’s warning about currency war risks.
But the IMF chief also said he didn’t believe there was momentum for a Plaza Accord-type deal on currencies. The 1985 agreement was made among major industrial nations to devalue the U.S. dollar in relation to the Japanese yen and German deutsche mark.
The IMF’s Dominique Strauss-Kahn sounds a warning in Washington about a lack of international cooperation at a time when the global economy’s still fragile.
Strauss-Kahn’s warning came a day after U.S. Treasury Secretary Timothy Geithner effectively blamed China for stoking a currency war. The world’s largest emerging market is facing pressure at the IMF’s meeting to slow pace of yuan appreciation.
The head of China’s central bank said Friday that an alternative “shock therapy” approach on the currency would be dangerous, but that China is committed to gradual exchange-rate reform.
Meanwhile, France’s finance minister called for currency “peace.” France will hold the Group of 20 presidency in November. Read more about Christine Lagarde’s remarks.
Bank of America/Merrill Lynch highlighted what it calls 10 key parameters to capture the motivation for intervention based on valuation; the costs versus benefits of having a cheaper currency; and affordability of interventions in an effort to gauge which countries need or want a cheaper currency and can afford to intervene.
On an affordability basis, the Czech Republic and Israel remain best positioned, according to the Bank of America analysis: “The interest rate differential versus core markets provides a simple measure of the cost of sterilizing interventions.”
The Czech Republic “has been quiet of late” in light of the performance of exports and foreign direct investment so far this year, the broker wrote. More verbal intervention could follow if appreciation in its currency reaches the upper end of its comfort level. Israel is likely to maintain the status quo with ad hoc interventions targeted at speculators, the broker said.
Meanwhile, recent comments by Poland’s central bank suggest “a more tolerant stance for now,” in light of limited nominal effective exchange-rate appreciation, and recovery in exports and growth since April, when the central bank had intervened.
A recent Polish central bank survey of exporters puts their “pain level” for the rate between the euro and Poland’s zloty at 3.72. “A rapid move toward this is likely to alarm the [central bank] and potentially spark some intervention,” said Bank of America.
Hungary was left off Bank of America’s list of intervention candidates, citing its open foreign-exchange position.
Vladimir Milev, portfolio strategist at Metzler/Payden Emerging Europe Fund (NASDAQ:MPYMX) , said that Hungary’s currency, in general, is worth watching.
“The dynamic of Hungarian lending was driven very strongly” by loans made in foreign currencies, particularly the Swiss franc, before the financial crisis, Milev said. When the forint was sliding earlier this year, “all of a sudden, your mortgage is 20% more expensive,” so those consumer-oriented concerns still carry weight, he said.
Further south, Bank of America estimated that South Africa bought roughly $3 billion this year, and that its style of “ad hoc and low profile” interventions is likely to remain so.
“Recent comments from policy makers suggest a cautious approach given portfolio flows dominate [balance of payments] financing, “ the broker wrote. “Still this remains a topical issue for South African policy, and more rather than less talk/action is likely going ahead if rand strength continues.”