In the reverse currency war, there is only one winner: McGeever

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ORLANDO — The dollar’s soaring to new highs, even as monetary authorities around the world raise interest rates or intervene to support their national currencies, shows that central banks fighting the “reverse currency war” are doomed to failure.

In the battle against an ultra-hawkish Fed, there is only one winner: the dollar.

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The third week of September 2022 gained instant historic status as the Federal Reserve’s third straight 75 basis point rate hike – and the promise of further tightening to come – sent global markets crashing and the dollar on the moon.

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Unfortunately for the rest of the world, a creeping dollar is an economic and financial wrecking ball that destroys most things in its path. And the destruction left in its wake only makes investors more likely to shun ruined currencies in favor of the greenback, intensifying the vicious circle.

Look at Sweden. The Riksbank stunned markets with a 100 basis point rate hike, the biggest since 1993, but the Swedish krona fell to a record low against the dollar, plunging more than 4% in the week.

The European Central Bank’s unprecedented 75 basis point rate hike the previous week and the promise of more to come did not prevent the euro from crashing to a 20-year low of 0.97 $ Friday.

The term “currency war” was coined by Brazilian Finance Minister Guido Mantega in 2010, in the aftermath of the global financial crisis, when weak exchange rates in developed economies helped boost growth and avoid deflation.

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The global post-pandemic inflation wave, however, has turned the tide, and central banks are now locked in a race to raise rates and kill inflation. The “reverse” currency war against the Fed and the dollar is much harder to win.

An IMF working paper released in July examining foreign exchange interventions in 26 advanced and emerging economies between 1990 and 2018 found that “intervening to reduce exchange rate misalignments resulting from long-term macroeconomic factors is unlikely to be efficient”.

Additionally, he also found that “currency sales appear to be somewhat more effective than currency purchases, and intervention is less effective in more liquid FX markets.”

Essentially, central banks are more likely to achieve their goals in a traditional “currency war” by selling their currency to keep it weak and competitive, than when stepping in to buy their currency with dollar reserves.

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EMERGENCY MEASURES

The wrecking ball of the dollar is being felt around the world, but is perhaps most painful in Tokyo and London.

The fall of the yen to a 24-year low against the dollar prompted the Bank of Japan’s first dollar selling intervention since 1998, and the fall of the pound to a 37-year low and the fall all as historic as gilts backed the Bank of England in one of its tightest corners ever.

Their fragility is revealing.

The BOJ joined a growing number of Asian central banks in intervening by selling dollars for their national currencies, eventually intervening to prevent the yen from sliding towards the 150/dollar mark. But analysts are skeptical of its lasting impact.

The BOJ has $1.3 trillion in foreign exchange reserves, mostly denominated in dollars. Even if this is the case, it is still a limited amount, so the BOJ’s firepower when it comes to buying Yen is also limited.

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The BOJ’s yen-buying intervention is also less likely to succeed as long as the BOJ keeps Japanese interest rates near zero and the Fed drives US rates ever higher.

The BoE, still marked by the “Black Wednesday” of September 16, 1992, when the collapse of the pound sterling forced Britain out of the European exchange rate mechanism, did not intervene to support the pound.

But calls for it to act are growing, especially after the market backlash against the government’s mini budget on Friday, which includes huge tax cuts and spending increases.

The pound fell 3.5% against the dollar on Friday. There have only been six steeper daily declines since floating exchange rates began 50 years ago.

The gilt market crash this week was even harder. The five-year yield rose nearly 100 basis points during the week, by far the biggest rise on record, while the 10-year yield jumped nearly 70 basis points, the most since 1981 .

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“The policy response required to what is happening is clear: a significant rate hike between meetings… as early as next week to regain credibility with the market,” Deutsche Bank’s George Saravelos wrote on Friday.

The dollar, meanwhile, is marching on. HSBC’s global multi-asset allocation now holds “maximum” underweight positions in developed market equities, high yield credit and sovereign bonds, the bank said, adding: “The single largest class of asset that resists is dollar cash”.

(Views expressed here are those of the author, columnist for Reuters.)

(By Jamie McGeever; Editing by Andrea Ricci)

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