Implied currency volatility levels across the major pairs have dropped to lows not seen since 2007, and equity markets are astonishingly stable. Although 10% corrections have hit stocks roughly once annually over the last century, it has been more than two and a half years since the last major drop in North America.
Signs of caution are emerging however. Many bourses are beginning the week on a softer footing, weighed down by geopolitical concerns and
holiday-related illiquidity. Hope that a diplomatic solution was in the offing has begun to fade after several people were killed in the eastern Ukraine over the weekend, helping to drive safe haven currencies higher and Brent prices upward.
The dollar is up, supported by the positive production and jobless data released last week. Treasury yields are regaining territory lost, helping to lift the currency against its major counterparts. Increasingly, investors are putting funds to use within the United States, rather than pursuing opportunities in the emerging and commodity-linked economies that were in demand for most of the last decade.
Yesterday, Japan released numbers showing that the country’s trade deficit had widened sharply – to 1.45 trillion yen in March, from 802.5 billion yen the previous month. With Shinzo Abe’s quantitative easing programme diluting the currency’s value and rising energy prices taking their toll on the resource-poor nation, the yen is under broad-based pressure on foreign exchange markets, opening up the possibility of another run at the 1.05 mark.
The Canadian dollar is trading with a weaker bias, with the Bank of Canada’s dovishness continuing to counteract optimism related to a recovery in US consumer spending. Oil prices are providing some support, but the bifurcated nature of the global crude market means that this is distinctly limited. Because Canadian crude is typically shipped into the North American basin, the West Texas Intermediate benchmark has more impact on the price that exporters receive, versus the Brent benchmark that dominates European markets. Tensions in Eastern Europe have boosted Brent far more than WTI, and this is unlikely to change in the short term.
It’s deja vu all over again. After an all-too-brief hiatus, pundits are once again berating the People’s Bank of China for intervening in the currency markets.
Numbers released recently showed that the Chinese central bank added more than $128 billion to its currency reserves during the first three months of the year, providing the clearest indication yet that the yuan’s weakness was largely driven by active intervention rather than any sort of economic rebalancing. It’s increasingly evident that policymakers are attempting to boost the country’s competitiveness by boosting exports – and this is beginning to trigger friction with major trading partners like the United States.
In its latest report, the Treasury Department declined to label China a “currency manipulator”, but said that it “took measures, including reported heavy intervention, to significantly weaken” the exchange rate during the first quarter – setting the stage for what will inevitably become a political talking point in the months to come.
Unfortunately, we suspect that the debate will miss the point yet again.
As the government pushes the exchange rate down, it makes exports cheaper while making imports more expensive – in effect, this subsidizes businesses while taxing household consumption. In doing so, policymakers are exacerbating the country’s reliance on exports and credit-fuelled fixed investment, and inhibiting the transition toward a more sustainable mix of activities.
In the event that the weakening trend continues, the global economic rebalancing that has begun in the past two years will be put at risk, and the consequences could be profound. We will be watching closely in the coming months to see if other reforms are enacted to offset the exchange rate impact – if we’re seeing a return to the stimulus programmes enacted in 2009, the risk of a hard landing in China will increase dramatically.