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Tracking Intervention Risks In The Majors

by Mansoor Mohi-uddin, Zurich, UBS Investment Research
13 November 2008

The RBA announced today that it had intervened for the second consecutive month in the spot currency markets. Though the risk of co-ordinated G7 intervention remains modest, the risks of unilateral intervention amongst the majors now are rising as Australia’s action shows.

The BOJ seems the most likely central bank to follow the RBA especially as the G7 last month issued a statement at Tokyo’s behest warning about excessive volatility in the JPY. The SNB also continues to warn on the CHF as its currency makes hew highs against the EUR. But its intervention track record has been very limited over the last couple of decades.

In contrast Washington and Frankfurt seem unconcerned by the sharp moves in the USD and EUR since the summer while the BOE continues to talk down the GBP despite the currency already having plunged across the board.

The Reserve Bank of Australia announced today that it had intervened again in the spot currency markets.

Though the RBA has been passively intervening to build up foreign exchange reserves over the last few years of AUD strength as Chart 1 shows, it has intervened now in the opposite direction on three occasions “to restore liquidity” when the AUD has plunged since the global credit crisis began last year. These episodes are August 2007, October 2008 and again today.

As Chart 1 shows the RBA is not trying to draw a line in the sand under the AUD. But its actions show how the risk of unilateral intervention is rising amongst the majors – even as the G7 remains unlikely to undertake co-ordinated intervention in the currency markets.

The Bank of Japan seems the most likely central bank to follow the RBA – especially as the G7 issued a statement at Tokyo’s behest at the end of October warning about excessive volatility in the JPY. In effect the other G7 member states have given Tokyo the green light to unilaterally intervene in the markets. As Chart 2 shows this would be the first time Tokyo has acted since March 2004. The authorities didn’t react when USDJPY fell to 95 after Bear Stearns failed in March. But when USDJPY fell towards 90 at the end of last month, Tokyo prompted the G7 statement, suggesting it is reaching the limits of its tolerance on the JPY.

The Swiss National Bank also continues to warn on the strength of the CHF. As Chart 3 shows EURCHF fell to a new low at the end of last month below the 1.44 level reached in the aftermath of the September 11 2001 attacks.

But the SNB has only intervened on two days in the past couple of decades in the spot currency markets and that was in the old DEMCHF exchange rate. This month’s intermeeting 50bps rate cut by the SNB suggests the Swiss authorities still want to use interest rate changes to stop excessive moves in the CHF for now.

The other major central banks seem much less likely to unilaterally intervene in the currency markets. Chart 4 shows the stance of exchange rate policy for the United States. Changes in Washington’s view on the USD tend to result in co-ordinated intervention with America’s other G7 partners. The period of ‘benign neglect’ of the soaring greenback in the early 1980s ended with the G7 Plaza Accord to weaken the USD in 1985. The ‘malign intent’ shown by President Clinton’s first Treasury Secretary Lloyd Bentsen towards the value of the USD against the JPY (in order to force Japan to open its markets more to US imports) ended with the 1995 Washington agreement to support the USD. And the effective pursuit of a ‘strong USD’ policy ended in September 2000 when the US along with the BOJ, BOE and BoC agreed to help the ECB defend the EUR against the USD.

During the Bush administration, Washington has followed a policy of benign neglect to the falling USD during this decade. This ended this summer when the record weakness of the greenback against the EUR at 1.60 forced both the Federal Reserve and the US Treasury to warn the markets sharply on the external value of the USD. Conversely, with the greenback now having rebounded back towards its long term fair value of 1.20 against the EUR, US policymakers have stopped commenting on the currency.

Similarly, the ECB seems little focused on the EUR now that it has fallen back from its record levels against the USD since the summer. Of course foreign exchange volatility has been extreme as Chart 5 shows. Indeed one month implied volatility in EURUSD has soared far above the levels reached in September 2000 when the ECB persuaded the Fed and other central banks to intervene together to support the EUR and restore order to chaotic trading. But at that time volatility was increasing as the single currency was becoming more undervalued and therefore misaligned. In contrast this year, volatility has soared again but the EUR has fallen back towards its fair value levels against the USD rather than becoming more overvalued (and misaligned).

Amongst the major economies, Britain’s central bank seems to be the only authority that is actively welcoming the weakening of its currency. This year Monetary Policy Committee members including Bank of England governor Mervyn King have repeatedly stressed the benefits of a falling pound for the broader UK economy. At the same time the rapid interest rate cuts by the BOE have helped push sterling down towards record lows against Europe’s currencies as Chart 6 of the GBP against the old DEM shows.

This month governor King warned the authorities did not want to see “a particularly sharp drop in the GBP” even as he noted that the current fall in the currency was inevitable to rebalance the economy. But for now the GBP remains above its lows recorded after it was ejected from the old European Exchange Rate Mechanism (ERM) in 1992. As a result the authorities in London are unlikely to consider following the RBA’s actions in the spot currency markets soon.

Bottom line: the RBA intervention today to support the AUD has increased the risk that other central banks also unilaterally intervene in the currency markets. The BOJ seems most likely to follow suit if USDJPY falls quickly towards 90. In contrast the SNB seems likely still to fight exchange rate strength through interest rate changes. Amongst the other major economies, the US, UK and Euro remain much less willing to consider unilateral intervention. This will keep the chances of co-ordinated G7 intervention modest too.

2 Kommentare

1 Der Gnom aus Kapstadt - 16.11.2008 um 9:16

Schon bald wird das Rennen für den großen Preis des niedrigsten Wechselkurses beginnen …. -:)

2 newstrader - 17.11.2008 um 9:46

Handelsgewichtete Währungsindizes im Vergleich seit Beginn Sep 2008

du musst angemeldet sein, um zu schreiben.