The ECB does not need verbal intervention do push the euro lower. Draghi can change rate and liquidity expectations without talking about the exchange rate, and the euro will likely follow. The Trichet era showed that trying to manage the currency through verbal intervention was pretty futile, says Simon Smith of FxPro.
In the interview below, Smith also discusses the need to taper QE in the US, Abe’s third arrow and other topics moving currencies.
Simon has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining FxPro in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital. He has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International. Simon holds an MSc. in Economics from the University of London and a BSc. from Brunel University.
- Expectations for QE tapering have been pushed back to 2014. Could the Fed even take one step further and increase bond buys?
That’s a pretty low risk event from my point of view. We saw limited changes to the statement in October, which to a degree increased the risk that the Fed started tapering at the December meeting. We’ll have to wait for the minutes to hear their view on the government shut-down to get a sense, if any, of how they view the risks from that. It’s been nearly 5 years now since the Fed started quantitative easing. As with Japan, the marginal returns from that are falling. USD 85bln a month has a lot lower impact on asset prices and the economy than would have been the case at the beginning. So, do more, you may say, but there comes a point where the benefits from that are going to start out-weighing the costs (bubble risks). That’s very hard to balance out, but in a relative sense there can be little doubt that we are a lot closer to that tipping point that was the case two years ago.
- The euro trades on high ground against the US dollar and against other peers. ECB president Mario Draghi mentioned the high exchange rate as a contributor to low inflation. Can we expect a more explicit complaint about the exchange rate in the upcoming meeting?
Remember, responsibility for the currency lies with the central bank, unlike many other countries where they are merely the agent of the government in carrying out any exchange rate policy or intervention. I think Draghi is too smart to start trying to ‘talk down’ the currency. He knows there will be limited benefit and greater risks that its effect proves to be very transitory. After the latest inflation data, it’s more likely that the currency will move lower on the back of revised interest rate expectations and/or increased expectation of more liquidity from the ECB in early 2014. This is where Draghi has had more of an impact on the currency, i.e. changing expectations on rates. The Trichet era showed that trying to manage the currency through verbal intervention was pretty futile, even when he managed to stop other central bankers talking about FX, dubbing himself “Mr. Euro”.
- Recent inflation data from Japan showed that the battle against deflation is having some results, with the “core-core” inflation not being negative. Can these signs of success encourage policy makers to introduce more measures (such as Abe’s third arrow or more QE) or rather enable them to let go?
Structural reforms are the most important arrow because it is more permanent. The monetary and fiscal arrows are a lot more transitory in nature, so this third arrow will make the difference between escaping from the deflationary malaise that has gripped Japan for most of the past 20 years or not. The appetite is within government still appears to be lacking to a degree and that has been Japan’s problem; an inability to move away from the way things have been towards the way they should be.
- RBA governor Glenn Stevens talked down the Aussie. Could the RBA also cut the interest rate once again before the end of the year?
I think is comments were perhaps not aimed at specifically talking down the currency in the near-term, more reflecting on that fact that in the big picture, on most measures it is still looking over-valued. It came at a time when the Aussie was already correcting from over-bought conditions, so from that perspective it helped continue that trend. I don’t see it prompting further rate cuts this year, but there remains a decent chance that we could see at least one more cut next year.
- The kiwi was hit by reports that Moody’s considered a downgrade and earlier by the dissatisfaction of the RBNZ with the exchange rate. Can talking alone continue keeping the New Zealand dollar from rising? Or will policymakers need to act to curb inflows?
The latest statement failed to make specific reference to the currency, so that at least caused some short-term relief on the kiwi. I think we are now at more comfortable levels and to varying degrees, all currencies which are operating an external deficit of more than 4% of GDP are vulnerable in a more risk averse environment. This is why the kiwi was one of the weaker currencies during the May to August period when markets were (incorrectly as it happens) adjusting to a world of tapering.
Further reading: New ECB measures could be introduced in December or JanuaryGet the 5 most predictable currency pairs