Which currencies will win?

Politics seems likely to dominate economics when it comes to the near-term outlook for major currencies such as the US dollar, yen and euro. The US has a government that is currently closed. Japan is going to have a new Prime Minister. And, in France, the new government is much like the old government which has failed to pass a budget, leading to the quick resignation of PM Lecornu. Political woes look set to usurp economic factors in the short-term, certainly in the US where the government shutdown will deny the market more potentially price-moving data releases this week after the absence of the crucial non-farm payroll data last week.

It is fair to say that political change in the US this year has cost the dollar significantly. Political change in Japan over the weekend, with the victory for pro-reform candidate Takaishi has done the same for the yen so far. While, in France, the political troubles for the government have seen their effects fall on the bond market, not the (shared) single currency. The government shutdown in the US is not unusual and, in the past, has seldom hit the dollar.

So far this one is no different but the implications of the closure could be very different if it allows the Administration to make wholesale cuts to federal employees. Add this to the tensions being created by the controversial deployment of the national guard across various US cities and it is fair to say that the political climate looks pretty febrile.

We cannot label the political situation in Japan in the same way but, all the same, the surprise victory for pro-reform candidate Sanae Takaishi could mark something of a watershed. For she was a staunch ally of former PM Abe whose dose of so-called ‘Abenomics’ during his tenure between 2012 and 2020 led to a dramatic decline in the yen, aided notably, by the adoption of very expansive monetary policy by the BoJ. More than a decade on from the start of Abenomics and the Japanese economy is in a different place, now most notably through the disappearance of deflationary pressure. Indeed, Abe’s policies seemed very successful in this regard which may be part of the reason why Takaishi was able to defeat frontrunner Koizumi for the LDP leadership.

The emphasis now on stimulating the economy and lifting inflation is not what it was in 2012 when Abe came to power. In fact, the need now seems to be to contain inflation. But Takaishi may try to use her position to dissuade the BoJ from moving too aggressively on this front; something that could weigh on the yen. So, while we do still see a stronger yen over time against the dollar, we have reigned in some of this forecast strength as a result of Takaichi’s victory.

If major currencies like the US dollar and the yen, and perhaps even the euro, stand to weaken as a result of political tensions, which currencies will win? The obvious answer would seem to be those currencies where politics is quiescent. Another answer is that no ‘currency’ is a winner. That instead, non-fiat assets like gold and crypto currencies win as part of what’s been called a ‘debasement trade’. What is meant by this is that noisy politics not only creates economic and social tensions but potentially undermines central bank supplied (fiat) currencies because part of this political pressure finds its way into relations between the government and the central banks.

This is all too clear to see in the US where President Trump not only heaps pressure on the Fed to cut rates, but does so to explicitly reduce the costs of government borrowing. In Japan, we’ve just mentioned how former PM Abe worked closely with the BoJ to ease monetary policy significantly via what was termed ‘quantitative and qualitative easing’ in 2013; something that helped initiate a dramatic slide in the yen and, in our view, increased concerns that the authorities were ‘debasing’ the currency.

Recent years have seen this debasement theme really come to the fore as alternative non-fiat assets like gold and crypto currencies have surged. Clearly this could all be a speculative bubble, perhaps not unlike the way that crypto currencies seemed to ‘bubble up’ in 2017 and again in 2021 before collapsing. But in the Standard Bank’s view, there may be more in the rally this time around and that could continue to mean that conventional (fiat) currencies continue to lose out to alternative assets like gold and crypto.