Fueled by the Federal Reserve’s dovish policy, US economic strength and investors looking for a haven from market weakness, the greenback is rising relentlessly against counterparts large and small at the most in decades. Japan is the latest major country to intervene directly in the currency dispute, joining nations from India to Chile that have tapped their dollar stashes in a fight against the mighty greenback.
While the current problems in the forex markets are in many ways reminiscent of the 1980s, the solutions are probably not. It was then that the world’s economic superpowers agreed to jointly tackle the problem of continued dollar strength, and in 1985 came to terms with the Plaza Accord. This time there is little sign that such a pact will materialize as national economic interests diverge and decades-long shifts towards greater global integration are reversed.
Coordination for a new Plaza deal would need to involve the US government, and there is “nearly 0% chance that the Treasury Department will step in to weaken the dollar right now,” said Viraj Patel, strategist at Vanda Research. “There is a ton of literature showing that ‘leaning against the wind’ in FX is a futile exercise when monetary policy has the opposite effect.”
The action taken by Japan on Thursday was fairly isolated, with a US Treasury Department official confirming it was not involved and the European Central Bank saying it was not involved in foreign exchange market intervention. A spokesman said the US Treasury understood the move but did not support it.
The devaluation of everything from the euro to the South Korean won is fueling already burgeoning inflationary pressures around the world, forcing many policymakers to reach deep into their toolboxes.
China, the world’s second largest economy, continues to mount its own defenses against the dollar with stronger than expected FX fixes. And central banks across much of the world — with some exceptions in Japan — are stepping in to raise interest rates as they grapple with rising consumer prices and currency depreciation.
The Bloomberg dollar index, which measures the currency against a basket of emerging and developed market counterparts, hit new highs this week after the US Federal Reserve reiterated its determination to raise borrowing costs to fight inflation.
This broad-based dollar strength, combined with the market fallout from the Bank of Japan’s recent decision, clearly proved to be too much for the Japanese government. Officials in Tokyo had previously spoken only about foreign exchange market concerns but stepped up their fight on Thursday, taking direct action to support the yen for the first time in decades. This was despite the fact that the central bank bucked the global tightening trend and stuck to its policy of keeping official borrowing costs low.
Japan joins a growing group of countries that have become directly active in the forex markets, including Chile, Ghana, South Korea and India. The Swiss central bank said in its policy decision on Thursday that it is ready to intervene in foreign exchange if necessary.
“Right now it’s an ‘every man for himself’ scenario because the world is much more fragmented today than it was in the 1980s,” said George Boubouras, a three-decade market veteran and research director at hedge fund K2 Asset Management. “The chances of global coordination weakening the dollar are near zero – expect more currency wars.”
A key difference from the 1980s is the sheer size of forex trading today, with an average daily turnover of $6.6 trillion during the Bank for International Settlements’ last triennial survey in 2019. That’s a significant increase from $5.1 trillion, larger than 1986 just three years earlier, when the BIS began this type of activity survey.
A steadily strengthening US dollar is leaving policymakers from Tokyo to Santiago in near-continuous firefighting mode to mitigate the damage to their economies. It also exacerbates an inflationary dilemma, the seeds of which were sown during the pandemic supply chain crisis and the Russian war in Ukraine. The dollar’s rise this year has already pushed up the cost of food imports around the world, triggered historic indebtedness in Sri Lanka and amplified losses for bond and stock investors everywhere.
However, as long as the Fed is raising borrowing costs faster than most of its peers, almost all other currencies will remain under pressure.
Unlike the 1980s, Japan is striving to maintain an ultra-loose monetary policy. BOJ Governor Haruhiko Kuroda, at a briefing on Thursday, insisted that no rate hikes were in the works and the guidelines for future policy would not be changed for the time being, even for two or three years in principle. And that means that the direct intervention, despite having more firepower in its reserves than the last attempt to support the yen, could ultimately be little more than a retreat.
Japan’s government “can only slow the slide until dollar momentum wears off or Japanese trade momentum reverses,” said Jeremy Stretch, head of Group of 10 currency strategy at Canadian Imperial Bank of Commerce in London, noting that he didn’t believe in a rerun of the Plaza Accord.
In Europe, the energy crisis and war in Ukraine are weighing on the region’s economy and potentially hampering the European Central Bank’s ability to follow the Fed’s rate hike path.
Greenback gauges at different levels compared to history but all rising
There are other fundamental reasons why a global pact to reverse dollar strength is wishful thinking, market participants say.
First of all, China is now the largest trading partner of the US, Japan and other countries across Europe. A deal without Beijing’s involvement would likely be an ineffective deal, and while the yuan is under pressure against the dollar and the government there is leaning against weakness with its fixings, it is far from distressed levels that would require Chinese cooperation. Given that this is primarily a story of dollar strength, the yuan is actually trading at historic highs against some of its major Asian counterparts.
More importantly, there is a staggering lack of US support to stem the dollar’s rise.
The dollar’s strength barely warranted a mention at the recent congressional hearings with Powell and Treasury Secretary Janet Yellen. And dollar strength is indeed helpful in resisting consumer price pressures, making imported goods and services cheaper while also acting as a potential headwind to growth.
“I don’t think a Plaza-type deal is likely, at least not until the Fed thinks it’s broken the backbone of the US inflation threat,” said Jane Foley, strategist at Rabobank in London. “The strength of the dollar is a by-product of its tight monetary policy, and efforts to weaken the dollar would be at odds with its policies of interest rate and quantitative tightening.”
While the fight against dollar supremacy may ultimately be futile without US support, policymakers have little choice but to continue to defend their currencies or risk widespread economic woes.
Chile’s central bank unveiled a $25 billion intervention plan in July, and Hong Kong’s monetary authority has been buying local dollars at a record pace to defend the city’s currency peg.
Collectively, developing countries are burning more than $2 billion worth of foreign exchange reserves every weekday to strengthen their currencies against the greenback, and strategists anticipate efforts to increase them.