Twelve weeks ago, at a G20 summit in Shanghai, the world’s big central banks worried about a highly volatile market and how to make monetary policy work.
They focused on currency manipulation as one of the causes of global economic instability and urged all countries to refrain from it. This weekend’s G7 gathering of finance ministers in Sendai gives them the chance to look at what progress has been made.
The evidence is pretty compelling. In those 12 weeks, the Federal Reserve has trodden a decidedly dovish line on rates, the European Central Bank has called a halt to taking interest rates further into negative territory, the Bank of Japan has refrained from further monetary easing and the People’s Bank of China has gone to war against speculators determined to drive the renminbi lower.
Currency commentators argue at length whether all these actions were co-ordinated via some kind of unwritten “currency wars truce” reminiscent of the 1985 Plaza Accord.
Alan Ruskin, FX strategist at Deutsche Bank, prefers to describe it as “an understanding”, and the understanding was that dollar strength was “starting to become problematic for global risk”.
Truce or not, the combination of these actions has resulted in a weaker dollar, a barely discernible shift in the dollar-renminbi rate, buoyant emerging market currencies, an oil price nudging $50 a barrel and a relatively becalmed market. All pretty painless, except for the eurozone and Japan, whose currencies have strengthened more than suits their economies.
Currency wars? Not this year. The only currencies to have weakened more than 1.5 per cent against the dollar so far in 2016 are Brexit-hit sterling and the Mexican peso. “A less strong dollar has been supportive for global financial conditions,” says Mr Ruskin.
It is hardly surprising, therefore, that the US government, wanting to keep things stable, has been upping the currency manipulation rhetoric.
The Treasury Department’s publication last month of a new currency watchlist, which includes China, Germany, Japan and South Korea, shows “they appear to be even more focused on that point [preventing currency manipulation],” says Stephen Jefferies, head of emerging markets and Europe, Middle East and Africa foreign exchange at JPMorgan.
The signs are that Treasury secretary Jack Lew will use the G7 at Sendai to reinforce the importance of exchange-rate stability, so Sendai will maintain the currencies equilibrium — but for how much longer?
“This is like a winter currency wars truce,” says Steven Englander, head of G10 FX strategy at Citigroup. “As soon as the ground solidifies, they will be back at it.”
Central banks have bought time with their package of currency-calming measures, though they have gone as far as they can. Dollar strength is warming up again, says Simon Derrick FX strategist at BNY Mellon, citing his bank’s flow data, plus the stalled rallies in gold and equities.
At a time of renewed pressure on the renminbi and Chinese economic data missing expectations, “the Fed will undoubtedly be alert to the possibility of another summer of unrest in financial markets”, says Mr Derrick — all the more so with a contentious US presidential election approaching.
On the other hand, believes Mr Ruskin, the US currency probably weakened sufficiently to cushion the impact of any renewed vigour in the dollar.
The Fed’s shifting expectations from four rate increases this year to two gives more breathing room for risk appetite and should reduce the potential for financial stress, he adds.
A currency truce may not bear any fruit in terms of actual data, says Mr Jefferies, “but the desire to keep currencies stable means it might have a bit more legs”.
The broader picture is more gloomy, because currency stability is masking failures in monetary policy. Each central bank is struggling with its own demons, says Mr Englander — the Fed fears hiking rates, the ECB fears taking monetary easing further, the BoJ fears further disaster if it extends its negative interest rates policy and the PBoC fears the debt growth that accompanies each easing strategy.
“The question is which central bank needs the move the most, and which can find a way of mitigating the downside of a rates change,” says Mr Englander.
Market commentators are asking not how long a currency truce lasts, but what comes after it. “If monetary policy is tapped out and currency depreciation outlawed, might fiscal expansion be the best way to get the global economy going?” asks Steven Barrow, FX strategist at Standard Bank.
Not from the Sendai summit, he acknowledges, because of the opposition of the Europeans. That can only mean the search for faster global growth will take that much longer, raising the prospect of countries becoming more insular and protectionist.
Currency volatility is low by historical standards, says Mr Englander, but it is unrealistic for central banks to have as their goal financial markets without volatility, no excessive speculation and only moderate appreciation in asset prices.
At some point, the US, Japan or China is going to decide that domestic policy needs trump FX stability, “and once one moves, the genie is out of the bottle”.