Who Wins in a Global FX War?

In my Daily Currency focus for FX360, I talk about whether Switzerland’s actions could trigger a Global FX War. The ultimate winner of any FX war is gold because if other central banks weaken their currency, then the only asset that isn’t facing selling by central banks is gold. Also Quantitative Easing will force central banks around the world to print money and gold is one of the few currencies that cannot be printed.

Here is a snippet from my story on the possibility of a Global FX War:

Is a Global FX War Possible?

In an environment of slowing growth and falling prices, every central bank wants a weak currency. However up until now, most major central banks have been reluctant to intervene in the foreign exchange market to artificially weaken their currencies because of the burden it would put on other countries.

Japan is a perfect example – the Japanese Yen has been skyrocketing but the BoJ did not sell Yen because they know that it would be counterproductive to the U.S. and Eurozone’s efforts to boost their own economy. In order for the Japanese economy to recover, their trade partners need to recover first.

However, today Switzerland has broken that unspoken truce of letting the market determine who gets to benefit from a weaker currency and who doesn’t. By becoming a massive seller of Swiss Francs, they are in effect artificially driving other currencies higher. This means that they are putting their own interests ahead of everyone else’s and unfortunately that may trigger retaliation by other central banks. A global FX war where central banks around world start (continue reading on FX360)

Euro and British Pound Crushed by Rate Decisions

The Euro and British pound have come under severe selling pressure after the ECB and BoE cut interest rates by 50bp. Interest rates are now at historic lows for both central banks and even though the rate announcements were negative for both currencies, the Euro has sold off more aggressively than the British pound because ECB President Trichet warned that growth will be signicantly reduced in 2009 and 2010 while inflation will remain well below 2 percent.

More importantly, he admitted that the ECB is studying non-standard measures which include quantitative easing. However, Trichet prefers to use the Fed’s label of credit easing over quantitative easing (What is the Difference Between Credit and Quantitative Easing?). The mere possibility that the ECB could consider Quantitative Easing was enough to drive the EUR/USD below 1.25. With the third highest interest rate of the G10 nations, further interest rate cuts are still possible. By saying that they have not made a decision about whether 1.5 percent is the lowest level makes 1 percent interest rates a real possibility for the Eurozone. In fact, Trichet may opt for another rate cut before credit easing. For the US dollar, British pound and Japanese Yen, no surprises are expected from future rate decisions. However for the Euro, the prospect of lower interest rates and the uncertainty of if and when the ECB will adopt credit easing should keep the EUR/USD under pressure.

Bank of England: Rates May Have Hit Rock Bottom

As for the Bank of England, I believe today’s 50bp rate cut to 0.5 percent is their last. The central bank has been worried that excessively low interest rates would erode profitability of banks, reducing their incentive to lend. Now that they have been given the authorization to begin Quantitative Easing, it will be their new focus. UK Gilts have soared on the announcement that the government will purchase up to £100bn in Gilts and £50bn in private sector assets (syndicated loans and ABS). As we indicated in our ECB and BoE preview, Quantitative Easing is negative for a currency, but if the BoE is done cutting interest rates, further weakness in the British pound may be limited.

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What is Quantitative Easing

The European Central Bank and Bank of England rate decisions are tomorrow. Both central banks are expected to cut interest rates by 50bp. For the BoE, the question is will they officially unveil a Quantitative Easing program and for the ECB, will they hint of one? Since Quantitative Easing will be the big story for the next 24 hours, it may be useful to review, What is Quantitative Easing.

Here is a great piece from Reuters:

March 4 (Reuters) – Central banks throughout the world are
considering or turning to non-conventional measures like
quantitative easing to keep credit flowing as they run out of
scope to lower benchmark interest rates any further.
But what is quantitative easing? Here are some details:

— Quantitative easing, notably employed by Japan from 2001
until 2006, refers to ways of boosting economic growth after
traditional monetary policy tools, such as interest rate
targets, have been exhausted.
— Central banks flood the banking system with masses of
money, more than is needed to keep official interest rates at
zero or a low rate, to shore up financial systems and promote
lending. They usually do this by buying up large quantities of
assets from banks.


— Economists agree the Fed’s various programmes to boost
the flow of credit through the expansion of its balance sheet to
over $2 trillion can be regarded as a form of quantitative
— On March 3, the Fed announced the details of the Term
Asset-backed Securities Loan Facility, TALF. A $200 billion
programme to lend against securities backed by student, auto,
credit card and business loans, TALF could expand to $1 trillion
and include troublesome mortgage and debt securities from banks.
— The Fed is buying highly rated, U.S.-dollar denominated,
three-month commercial paper through a special purpose vehicle
to run until Oct. 30.
— In January, the Fed started a programme to buy $100
billion in the direct obligations of housing-related government
sponsored enterprises — Fannie Mae, Freddie Mac and the Federal
Home Loan banks — and $500 billion in mortgage-based securities
backed by Fannie Mae, Freddie Mac and Ginnie Mae.

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Canadian Dollar Hits Targets

After the Bank of Canada cut interest rates by 50bp this morning, my target of 0.8350 in AUD/CAD has been reached. Yesterday, when the currency pair was trading at 0.8122, I argued that the possibility of the Reserve Bank of Australia leaving rates unchanged and the possibility of the Bank of Canada being more dovish would drive an upside breakout in AUD/CAD.

As for the Canadian dollar, I am still looking for it to fall to 1.30 against the US dollar. The rate decision has already driven USD/CAD to an 11 week high.

Not only did the Bank of Canada cut interest rates, but they talked about Quantitative Easing AND further rate cuts. Next stop for Canada is zero interest rates!

As for the Australian dollar, their “surprise” decision to leave rates unchanged should not have been much of a surprise to my readers as we talked about it yesterday. Over the past few weeks, comments from RBA officials have been surprisingly optimistic which should have been a signal for all traders that leaving rates unchanged is an option. Last night, RBA Governor Stevens said that There has already been a major change in both monetary and fiscal policy. The board will consider the position again at its next meeting.” In the RBA’s eyes, they have done alot. They are not closing the door on further rate cuts, but for the time being, they want to give the economy time to absorb the government’s aggressive fiscal and monetary stimulus.

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Bernanke Rebrands Quantitative Easing as Credit Easing

For the first time since cutting interest rates to 0.25 percent, Federal Reserve Chairman Ben Bernanke outlined his plan of action. In a speech at the London School of Economics, Bernanke talked about the additional tools available to the Fed, an orderly exit strategy, concerns about inflation and suggestions about how the Obama Administration should use the remainder of the TARP funds.

What is the Difference Between Credit and Quantitative Easing?

Most importantly, Bernanke created a new name for his regime – credit easing. In contrast to Quantitative Easing, which Bernanke explains focuses on the liabilities portion of the central bank’s balance sheet, Credit Easing focuses on expanding the asset side of the balance sheet. However since the balance sheet is suppose to balance, this may just be a difference of semantics since both efforts ultimately add liquidity into the financial system. The Federal Reserve wants to draw a distinction between their current policies and the Bank of Japan’s policies between 2001 and 2006.

The Fed’s Toolbox

As for the tools that they have at their disposal, there was nothing groundbreaking. Their number one tool is policy communication, followed by liquidity facilities for banks, facilities for other markets and purchases of long term securities. Like Federal Reserve President Lockhart, Bernanke expects interest rates to remain low for an extended period of time.

Inflation Concerns and Exit Strategy

As we expected, inflation is not a concern because the Fed believes that weaker growth will keep inflation low. In terms of an exit strategy, he expects demand for the emergency facilities to wane as the US economy improves.

Use of TARP Funds
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