Tags: Bank of Canada | Bank of England | Central Banks | ECB | Federal Reserve | Reserve Bank of Australia | Reserve Bank of New Zealand

Volatility has increased in the currency market due to the significance weakness of the U.S. dollar. Central bankers across the globe are starting to become fidgety while traders and investors are on the lookout for intervention. Over the past 6 months, the dollar has fallen more than 10 percent against most of the major currencies. In some ways, a stronger currency has the similar effect on an economy as a rate hike but the difference is that central banks control the timing of a rate hike but not foreign exchange fluctuations.

United States - Federal Reserve

Of all the major central banks, the Federal Reserve is the least worried about the recent fluctuations in its currency. In fact, the Fed is basking in dollar weakness. The global financial crisis has driven inflationary pressures to very low levels while the recent plunge in commodity prices reduce price pressures even further, making one of the primary concerns of a weak currency obsolete. Instead, the U.S. economy is experiencing only the benefits of a weak dollar which includes foreign demand for U.S. exports, real estate and U.S. companies. It also helps to boost the foreign earnings of U.S. multinational corporations which could make for a particularly jolly earnings season in the third quarter. Although the Federal Reserve and other members of the U.S. government could say that they support a strong currency, any reference would represent nothing more than lip service to the policy.

Eurozone – European Central Bank

One of the primary reasons for the EUR/USD’s resiliency is the European Central Bank’s lack of concern about the recent appreciation of their currency. The most that we have heard from the ECB was Trichet’s comment this morning about how a strong dollar is very important. Unfortunately this often repeated comment was not enough to trigger a sharp sell-off in the euro. In the past, the EUR/USD has only topped out when Trichet talked about the currency or expressed his concern about excessive foreign exchange fluctuations specifically. Instead, we have heard more positive than negative comments from ECB officials. According to Trichet, the economic situation has improved since March. Last week, Weber said that currency fluctuations were in line with “some stronger data coming from the Euro-zone” while this morning Nowotny said there is no need for ECB to change policy stance right now even though they are thinking about exit strategies. Typically, the European Commission or members of the European Union are the first to complain about currency strength and so far, they have also been quiet.

Australia – Reserve Bank of Australia

Next to the Federal Reserve, the central bank that is the least concerned about the recent appreciation in their currency is the Reserve Bank of Australia even though the AUD/USD has appreciated close to 25 percent over the past 6 months. Not only did Australia skirt a recession, but it has benefitted from the U.S. recovery, stimulus in China and the previous rise in commodity prices. Based upon this morning’s comments from Governor Stevens, the RBA should be the first major central bank to raise interest rates. He referred to the cash rate as being “unusually low” which implies that they could normalize rates as early as this year “ahead of a buildup of imbalances that would occur if interest rates were kept low for too long.” Stevens also hinted that the central bank could upgrade their growth forecasts as a sound financial system, strength of their trading partners, substantial improvements in business and consumer confidence, higher share and house prices bolsters the economy.

United Kingdom – Bank of England

Of all the major central banks, the Bank of England is the probably the most dovish. The British pound collapsed last week because they are the only ones who still looking to implement easier monetary policy. Furthermore, the mixed messages from U.K. officials suggest that the BoE has dollar envy. Last week, the British pound sold off aggressively after Bank of England Governor King talked about the merits of a weak sterling which suggests that he supports one. On Friday, Finance Minister Darling tried to temper the weakness in the pound by saying that King’s comments were directed at exporters and the U.K.’s policy on the pound is unchanged. However the more that they try to backtrack their comments, the more convinced we are that U.K. officials have dollar envy. The weakness of the dollar is keeping the U.S. recovery on track and if the pound weakened as well, it could reduce the need for further stimulus.  Alternatively a stronger currency makes the central bank’s job all that more difficult.

Japan - Bank of Japan

The recent political shift in Japan has altered much of the country’s longstanding intervention traditions. Earlier this month, the new Finance Minister (Fujii) said that he is “against intervention if their moves are gradual, and we can't conduct intervention because the current foreign exchange markets won't move without a joint intervention.” Unlike the previous party that targeted a weak yen to boost exports, the focus of the new administration is to boost domestic demand. However, the Democratic Party and Fujii are beginning to quickly realize that politics can be tricky. To appease the export sector and their constituents, Fujii retracted his comments a few days later by saying that the yen should reflect fundamentals and government officials should limit their comments about currencies. However, expectations have been set and it is now clear that the new party will be less worried about yen strength than their predecessors. This morning, Fujii said the recent movements in USD/JPY are not abnormal and the trade minister is investigating how much a stronger yen really hurts Japanese exporters.

Canada – Bank of Canada

The Bank of Canada on the other hand is growing increasingly uncomfortable with the strength of their currency. In July, the Canadian dollar skyrocketed because of the central bank’s unusual optimism, but earlier this month, the BoC toned things down significantly. At the time, they said as long as inflation does not skyrocket, interest rates will remain unchanged until the second quarter of 2010. However last week, the BoC took things one step further. Canadian Finance Minister Jim Flaherty proposed an expansion of mortgage buy-backs to C$125 Billion or $116.4 Billion, which represents a return to easier monetary policy. The proposal comes on the midst of  comment by Governor Mark Carney who claims the recovery is not “self-sustainable” and is a mere consequence of unconventional measures. On Friday, Carney also said he would provide more stimulus if needed while Deputy Governor Longworth said the currency Is a risk to economic recovery.  Although we do not expect intervention from the Bank of Canada, if the Canadian dollar continues to rise, the BoC could grow more dovish.

New Zealand – Reserve Bank of New Zealand

The Reserve Bank of New Zealand regularly expresses concern about their currency, but recent improvements in the economy have reduced the need for physical intervention. Earlier this month, RBNZ Governor Bollard said that gains in the currency are undesirable and does not help to rebalance New Zealand’s economy. Finance Minister English also said that “the high dollar is making it more difficult for the export sector to get off the floor”.  However compared to previous comments about the currency, this represents less rather than more concern. Intervention in New Zealand is not a risk at this time.

Switzerland – Swiss National Bank

Finally, the central bank that is the most worried about their currency is the Swiss National Bank. They intervened back in March and June and have done an effective job of keeping EUR/CHF above 1.50. However in recent weeks, the Swiss Franc has appreciated significantly against the U.S. dollar, raising some concern within the SNB. Last week, SNB board member Jordan said that further franc strength is unacceptable but so far we have not seen any signs of intervention which may be due to the fact that EUR/CHF is still holding above the 1.50 level. 

What this means for currency trading is the more concerned a central bank is about the level of their currency, the less likely that we will see further appreciation and the greater risk of either verbal or physical intervention.