Eyeing a turnaround in the greenback

USD rose to a record high against major currencies.

>> The reasons for the USD dollar’s rise

The pound can now be added to the yen as a currency that’s under huge pressure, possibly requiring the intervention of the UK government and/or BoE, just as we have seen in Japan. Undoubtedly, we can argue that these policymakers have been the architects of their currency downfalls.

The Bank of Japan has refused to join the global tide of monetary tightening while, in the UK, the government’s mini budget was perhaps the worst fiscal mismanagement the country has ever seen. But they both share the pressure of a surging dollar, as do all counties and, in the end, stopping the bleeding in weak currencies like the yen and the pound – and the euro – will probably require the help of the strong-currency country, the US.

But is that likely to happen? Not at this stage; the US is notoriously reticent to act in these sorts of circumstances. We certainly think it will be reticent to intervene in the FX market until such intervention is consistent with the stance of monetary policy.

For why tighten financial conditions with rate hikes while easing financial conditions through weakening the dollar? The market will just see through it. Hence, at a minimum Mr. Steve Barrow, Head of Standard Bank G10 Strategy,  thinks that intervention won’t occur until the Fed has stopped hiking rates, and more likely once it has started to cut rates, and that could be more than a year away. In the meantime, the bleed out in major currencies could be dramatic with sterling slumping through parity and the euro falling below historical lows of 0.82.

If the salvation from a watery grave is to be avoided for currencies such as the yen, euro and pound, we will need to see some quick signs of lower inflation, dovish hints from the Fed and hopes that global growth can recover quickly. Admittedly, there’s no real sign of any of these things yet and may not be for some time. But we do have to bear in mind that when these things start to happen the snap-back in currencies could be very dramatic and the dollar will likely lose a lot of ground pretty quickly.

Indeed, this sort of scenario is one of the reasons why we hold out longer-term hope for dollar weakness and a recovery in the pound back to the 1.30-1.40 region or 1.30 for the euro and 100 for the yen. “This may seem far-fetched at this juncture but we have argued many times before that the parallels today are with the late 1970s and early 1980s when oil prices and inflation were surging and where the Fed hiked rates dramatically. The dollar also soared; by around 50% in trade weighted terms in the 1980-85 period. But, the subsequent reversal was even more dramatic as inflation fell, and Fed FX intervention turned the dollar tide. Indeed, it was only a few years after the intervention of September 1985 that central banks and finance ministers had to step in again to try to stop the dollar from falling too far”, said Mr. Steve Barrow.

>> What if the Bank of Japan intervenes in USD/JPY?

Now quite clearly, we can’t say that this is how things will play out again in coming years but the point we’d make is that inflationary episodes can generate a significant flight to the dollar, which can be rapidly reversed as price pressures ease and the Fed cuts rates. The question from this period is whether the dollar only turned because of intervention. That’s important because, if that’s the case, it might require intervention again now to turn the dollar, even once inflation recedes, growth recovers and the Fed stops hiking rates.

The bottom line is that the dollar will turn in time, either because the global economic and financial market environment turns more positive, or because the Fed turns the dollar with intervention. But neither seems to be on the cards soon; certainly not this year and perhaps not even through the first half of next year either. In the meantime, the euro is seen falling further alongside other major currencies with perhaps only the yen able to hold its own against the dollar thanks to BoJ intervention.