What happens when US Dollar continues to weaken?
It is perhaps too early to come to any reliable conclusions regarding so-called dollar strength or weakness but events of this week must scare the governors of both the European Central Bank and the Bank of Japan. When first the notion of a currency war was mentioned some years back, the general opinion was that the major onslaught will come from those currencies used most for trade with the United States. These are the Euro, the Yen and the Yuan.
As I pointed out then, international trade is a zero sum equation and the others can only weaken and remain freely convertible if the US Dollar strengthens. That turned out to be exactly so. While the European Central Bank and Bank of Japan aggressively pursued policies to enhance liquidity thereby weakening their currencies, the US Federal Reserve’s umpteen stimulus packages had little effect in their own markets. Still on an international trade comparison, the US Dollar appeared stronger since the other major contenders were all becoming weaker.
Trying to understand the underpinnings of the currency war, it is often easier to grasp the technicalities than what it is to understand the motives behind the various central banks. Europe and Japan followed fairly transparent processes, announcing and publishing all additional liquidity stimulation in advance, but the People’s Bank of China was not so forthcoming or so transparent. A unilateral devaluation in the last quarter of 2015 produced much instability in Chinese stock markets which has not abated to date. In the meantime, the Euro and the Yen continued to depreciate steadily, creating the appearance of a stronger US Dollar, at least in markets outside America.
These events in foreign currency markets would to us remain mostly academic were it not for the detrimental impact it had on so-called emerging market currencies. For the likes of the Rand, the Rouble, the Real and the Rupee, dollar strength meant reverse weakness. Tie this to the fact that international markets have become extremely sensitive to policy and growth issues and it shows why the Rand took such a beating.
This week provided a strong glimpse of what can possibly happen when the US Dollar depreciates. Over the course of only four trading days, the Dollar lost about 1% in value, or rather the Euro and Yen appreciated by so much. The first immediate side effect was an across the board appreciation of about half a percentage point for emerging market currencies. The Rand during intra-day trade on Thursday, twice touched the R15-78/US$ level before closing the day at R15-86/US$. This is a marked improvement on the dismal Rand value at the end of last year and the beginning of this year. And it happened contrary to consensus opinion.
The outlook for the South African economy has not suddenly improved, and the stooge who started the calamity is still in charge, but inexplicably, foreign investors look keener at Rand-denominated transactions.
Compare the Rand movement of the week with the trend on the JSE and it shows that the currency appreciation was synchronised with improved trading. The JSE allshare shot up by more than 2% in a single day mirrored by commensurate but not as drastic moves in Europe and China. And it has all to do with Dollar depreciation and not with sentiment or what any particular clown does.
Does it mean the currency war has now reversed and that American investors will continue to wag the whole rest of the world? I certainly think so. It was not clear exactly why currency investors were releasing their Dollar positions, but the fact that they did, had a major impact on all other currencies.
It is difficult to fathom these motives since we are not privy to those meetings where these investment decisions are taken, but if the US Dollar continues to depreciate, it automatically means all the other currencies, both developed and emerging, will also continue to appreciate. Furthermore, a strong US Dollar will eventually undermine the gold price, and reverse the slide in the oil price. Expect this to happen to other commodities as well.
In a week and a half the Bank of Namibia has another Monetary Policy Committee meeting. In my view it would be a serious mistake to increase interest rates like the South African Reserve Bank did a week ago. After all, again against all expectations, long-term US interest rates have not followed the cue from the Federal Reserve. Instead of rising, they have been going down.