Recent action by central banks around the world has led to some increased volatility in major foreign exchange markets. This month has already seen rate cuts in Europe and Australia and the Yen sinking to a new multi-year low against the U.S. Dollar. While these central bank actions are meant to stimulate weakened global economies many are concerned that the increasingly easy monetary policies being adopted around the world may be setting the world’s largest economies on a path towards an environment of competitive devaluation.
The first to take action this month was the European Central Bank. After a May 2nd meeting the ECB responded to persistently weak economic data and sluggish growth with a long anticipated cut to benchmark interest rates. ECB president Mario Draghi announced that the rate would be lowered by 25 basis points to a new record low of 0.50 percent. Draghi’s comments suggested that there were several members of the ECB that pushed for an even larger cut. Draghi also reiterated that the ECB would stand ready to act if economic conditions continue to deteriorate. Smaller members of the Eurozone have already criticized the ECB for doing too little too late, and there is a serious concern that the recent rate cut will not be effective. Later this week the Eurozone will report their first quarter GDP numbers. Should this data look weak the ECB may feel pressure to purchase asset backed securities in a quantitative easing program, which would undoubtedly produce further downside for the Euro. Traders are already speculating on a lower Euro with June Euro FX Futures breaking the key 1.30 level last week.
The Reserve Bank of Australia also responded to sluggish growth in their economy last week by cutting their benchmark interest rates from 3 percent to a new record low of 2.75 percent. The rate cut follows recent months of soft economic data including extremely weak retail sales numbers released May 3rd. The Australian economy is heavily tied to commodities, with the mining sector alone representing 10 percent of the county’s overall GDP. A strong Australian Dollar and falling commodity prices have done a lot to hinder growth. Chinese PMI has also fallen to the lowest levels since 2011. A slowdown in China would mean lower demand for oil and iron ore in Australia’s largest export market. The surprise rate cut is an attempt to bolster the country’s waning export market and increase credit demand.
While the aforementioned economies are hastily attempting to put out fires, the Bank of Japan has been content in allowing their own economy to heat up. The Topix and Nikkei indices have been the top performers since the Japanese central bank began unprecedented levels of quantitative easing in mid-November. Just today the G7 leaders issued confirmation that they would allow this easing to occur unmolested, and the Yen was driven to 102¥/USD for the first time in 7 years. The advance of the Nikkei under devaluation duress could be a blessing or a curse, however, as foreign investment could partially offset the inflation that was the goal of the open-market operations by the BoJ. If this was to occur, and Shinzo Abe and his compatriots desired the continuation of this bloody-minded pursuit of inflation, we may see further action from the central bank in the near future to correct any imbalance.
Today’s statement from the G7 is encouraging. Unlike the early QE efforts from the world’s largest economies, which were met with nothing but vitriol and mistrust the localized devaluation of currencies has been performed in a much more open and cooperative manner in more recent times. There are limits to tolerance, though, and many central banks are politely pushing their own programs to those limits. There are not direct retaliatory ‘attacks’ occurring at this point, but it may be only a matter of time before one central bank truly draws the ire of another.