While a certain social-media site, the global currency markets are arguably the wilder and perhaps more important,
Asian currencies, notably China’s yuan and Japan’s yen, took their sharpest dives in years, while the other side of the globe, the euro slide to a five-year low. To be sure, most of the drops reflect the strength of the greenback, resulting from the surge in US bond yields this year. But there are other, specific aspects that are roiling currencies.
Permit a digression into a bit of theory here. Policy makers confront a trilemma; They can control only two of three factors: domestic monetary policy, exchange rates, or capital flows. In most advanced economies, the free flow of capital is permitted, leaving the choice between adjusting the currency’s value or domestic policy (in most cases, through interest rates). More often than not, when those two latter considerations come into conflict, it is the currency that adjusts rather than the domestic policy.
That is the most obvious present in Japan, where the yen plunged past 130 to the dollar this past week, a 12% weakening just early March and a 20-year low. That was capped by about 1.8% lurch downward afterwards
Bank of Japan
The 10-year government bond’s yield on the affirmed cap is 0.25%. Newly printed yen with more bonds, depressing the currency.
This marks a significant change for the yen, which has been seen in volatile times, rather than as a center of volatility. The Bank of Japan governor Haruhiko Kuroda on Thursday reiterated the central bank’s policy of yield-curve control and endorsed a weak yen as a positive for Japan’s economy. But a month ago, the BoJ’s aggressive monetary expansion boosted the economy. Indeed, the weak yen is the exacerbating burden of soaring oil prices, which are invoiced in dearer dollars.
The decline in the yen has rippled throughout East Asia, especially China, adding to the pressure from the self-inflicted harm wrought by the nation’s virtual shutdown of major cities, including Beijing and Shanghai. Nevertheless, China’s President Xi Jinping has reportedly ordered a 5.5% increase in economic growth this year, topping the US, reports The Wall Street Journal.
5.5% Growth in Any Notion 2022 died at the moment big cities begin their descent into Covid Zero lockdown, writes Leland Miller, CEO of The Authoritative China Beige Book Advisory, in an email.
Notwithstanding Xi’s comments, investors should ignore any year-end growth estimates coming out of China, Miller continues. Actual growth will be determined by the extent of Covid lockdowns over the next six weeks. “If you’re a China bull, you better be praying that the lockdown reports are out. But I won’t bet on it, ”he adds.
Against that deteriorating domestic backdrop, Chinese authorities have opted to drop the tightly controlled yuan exchange rate sharply, by about 3.9% against the dollar since mid-April. That was the steepest decline since the 2015 mini-devaluation that roiled global markets, Julian Emanuel, chief equity and derivative strategist at Evercore ISI, points out in a client note.
The People’s Bank of China’s mandate is to maintain “relative stability” in the yuan “a sea of distress,” Miller adds. Rising domestic pressures, global central bank policy-rate hikes, and the surging US dollar. To some extent, the yuan’s lurch lower is a catch-up move to emerging market currencies that have been slumped against the greenback, according to a research report from Alpine Macro.
That said, Yuan’s sudden drop follows other domestic monetary and fiscal measures (including many more infrastructure projects) that have taken Beijing on lockdowns with the brake on the other foot.
At the same time, the euro has slid about 8% since January to a five-year low of around $ 1.05. Russia’s invasion of Ukraine, which began on Feb. 24, but the decline of the common currency was already under way earlier. Since late May, it’s down 14%.
The European Central Bank is expected to follow the Federal Reserve and increase its key deposit rate from negative 0.5% this summer. The Fedures market now thinks that the Futures market is below the 2.00% -2.25% range, according to its July 26-27 policy meeting. the CME FedWatch site.
The ECB faces a policy conundrum. Russia’s war on Ukraine has pressed euro-zone economies, mainly from the soaring price of oil and gas. That, in turn, has been exacerbated by the decline of the common currency, which has made dollar-denominated commodities even more expensive. With euro-zone inflation running at an annualized 7.5%, the ECB would be expected to lift its policy rate out of negative territory. But lacking strong domestic demand, Alpine Macro says, the economic bloc depends on exports to China and the US, which could falter if those two economies stumble.
The strong dollar, however, is the Fed’s effort to help reinforce inflation, doing some of the work’s expected interest-rate hikes. But as first-quarter earnings reports from US multinationals show, the greenback is a drag on overseas earnings.
Whatever the impacts, volatile currency markets tend to reflect unstable conditions that can find their way into bond and stock markets. For that reason alone, they should be on investors’ radar.
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Write to Randall W. Forsyth at email@example.com