One of the things that raises a wry smile is themes that go around and then pretty immediately crash and burn. That has been happening in currency markets. There have been various claims that events will end the dominance of the US Dollar with other currencies taking its place. Some considered last week’s move by Israel as evidence of this.
Israel’s central bank has made the biggest changes to its allocation of reserves in over a decade, adding the Chinese yuan alongside three other currencies to a stockpile that last year exceeded $200 billion for the first time ever. ( Bloomberg)
This was reported as a downgrade for the US Dollar when in fact the biggest move was elsewhere.
To accommodate the changes, the euro’s share will fall to 20% — the lowest in at least a decade — from just over 30%, while the dollar will account for 61%, down from 66.5%. The pound’s weighting, by contrast, will almost double to 5%, returning to a level last seen in 2011. ( Bloomberg)
From a UK point of view it is interesting to see the UK Pound gain some official support but as you can see the main loser here was the Euro. The winners are below.
the currencies of Canada and Australia will have 3.5% each. Under the new approach, the yuan’s proportion is set at 2% for 2022, according to the Israeli central bank’s annual report published at the end of last month. ( Bloomberg)
So we see Israel reflecting the commodity strength of Canada and Australia and giving a nod to China. They also added 5% for the Japanese Yen.
Meanwhile if we move from rhetoric to financial markets we see a different story. From the Financial Times yesterday.
The US dollar rallied to its highest level since March 2020 on Monday and is on track for its best month since January 2015, buoyed by expectations that the Federal Reserve will have to lift interest rates aggressively to tame inflation.
The dollar index, which tracks the US currency against six others including the euro and sterling, rose by as much as 0.8 per cent to a high of 101.86. The index has risen roughly 12 per cent in the past year.
There have been more headlines on this front since then.
The euro has tumbled to a five-year low against the US dollar…………The European common currency fell further on Wednesday morning after hitting its weakest point since April 2017 late in the previous New York session, according to Refinitiv data.
The whole concept is so painful for the FT they do not give a price so let me point out it has fallen below 1.06 this morning. If we stay with the Euro it has created something of a brain fart from Robin Brooks.
EUR/$ at 1.06 looks weak (white), but it isn’t. The Dollar is super strong, which drags up Euro in trade-weighted terms (orange). Once you adjust for that, what looks like a weak 1.06 is more like a strong 1.40. Not the right level given the Euro zone is going into recession…
Er a strong Dollar drags down the Euro but anyway we see that it may have what we dread in the UK which is inflationary versus the US Dollar and commodities but deflationary versus other trading partners.
Speaking of the UK Pound it has been hit recent falling below US $1.30 on Friday and then following equity markets lower this week to below US $1.26.
If we look to the orient we see more signs of pressure building. On Monday last week I looked at the way the Japanese Yen was devaluing. To that we can add concerns about the Yuan or Renminbi of China. From YuanTalks on Monday.
What is causing this?
One factor in this game is a change in perceptions about the US Federal Reserve.
The futures market is projecting the Fed will raise its main interest rate to 2.77 per cent by the end of 2022 — up from expectations of around 0.8 per cent at the start of the year — including three half-point raises in the coming months. ( FT)
I say perceptions because so far we have had only one interest-rate increase but financial markets are expecting more. This will especially support the US Dollar against the Yen and Euro who are limited on this front and indeed the Yuan where we may even see an interest-rate cut.
The first component of this is the simplest or actual fear about the war in Ukraine and its consequences which leads a move to a perceived safe haven.This time around there are fewer of those in sight as the Japanese Yen has fallen as there seems little sign of its large foreign investments being repatriated. Also the Euro which in recent times has had elements of safe haven moves is on the front line.
Another factor this week has been financial fear with equity markets falling leading to a stronger US Dollar. There is an irony as the main equity markets are in the US but it happens anyway.
As commodity prices rise importers need more US Dollars to buy the same amount. Thus more Euros, Yuans, Yen and Pounds need to be exchanged leading to price moves.
What is not causing it
Economics 101 would have this pushing the US Dollar lower.
For 2021, the U.S. trade deficit was $859.1 billion, according to the U.S. Bureau of Economic Analysis (BEA). The U.S. imported $3.4 trillion in goods and services, up $576.5 billion from 2020. Exports were at $2.5 trillion, marking a $394 billion increase from 2020.2
The 2021 trade deficit was significantly higher than that of 2020, in which the trade deficit was $676.7 billion. The COVID-19 pandemic and supply chain issues had a dramatic effect on imports in 2021. The current deficit sets a new record over the previous high mark of $763.5 billion in 2006. ( The Balance )
Care is needed as in real terms the numbers will be different but even 2022 so far adds to the theme of a trade position which should be pushing the US Dollar lower according to economics 101.
Year-to-date, the goods and services deficit increased $45.7 billion, or 34.5 percent, from the same period in 2021. Exports increased $68.0 billion or 17.6 percent. Imports increased $113.7 billion or 22.0 percent. ( US BEA)
There are various impacts of this and if we look at the US the simplest is that for a given amount of US Dollars they can buy more foreign goods and services. That is more woe for economics 101 as it will further worsen the trade deficit although according to the Federal Reserve the export position is worse.
the response of U.S. real exports to a 10 percent dollar appreciation that is derived from a large econometric model of U.S. trade maintained by the Federal Reserve Board staff.4 Real exports fall about 3 percent after a year and more than 7 percent after three years.
That was from a speech from Vice-Chair Stanley Fischer who thought the import reaction would be lower.
The low exchange rate pass-through helps account for the more modest estimated response of U.S. real imports to a 10 percent exchange rate appreciation shown by the thin red line in figure 2, which indicates that real imports rise only about 3-3/4 percent after three years.7
This is contractionary for the US economy.
The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years.
The extra US imports will boost other economies but then they are presently struggling to afford US goods and commodities priced in US Dollars.