Currency wars

We finished 2014 with everyone debating the perceived “war” between Saudi Arabia, Iran, Russia and the American shale oil producers. In the first month of 2015, we are seeing a different kind of battle take center stage: one between currencies. On Jan. 15 the Swiss National Bank announced it would go further into Negative Interest Rate Policy territory by lowering its interest rate from negative 0.25% to negative 0.75% and remove its peg to the euro. This sent shock waves across all currency pairs with the USDJPY initially taking the most heat. While investors were busy speculating about what action the European Central Bank (ECB) and Mario Draghi would take on Jan. 22, the Bank of Canada stole the spotlight by cutting interest rates from 1.0 to 0.75 on Jan. 21. Canada, a large producer of oil, has seen its currency under pressure of late as a result of sharply lower energy prices.

Dominating financial news on last week, the ECB’s Mario Draghi announced that the central bank would buy €60 billion worth of government debt, alongside asset-backed securities and covered bonds to rid the Eurozone of deflation that threatens to wipe out any chance of meaningful economic recovery. The program is slated to come to an end in September 2016 or until inflation reaches about 2%, meaning that at least €1 trillion will be injected into the economy of the Eurozone. The chart below shows the resulting decline in the euro, falling some 4.5% in all but one week to the currency’s lowest levels since 2003 with little support in sight.

Source: https://www.tradingview.com/e/lzCxUlF7/

The plan outlined by the ECB on Thursday is primarily concerned with combating deflationary concerns and stimulating economic growth. However, there is a danger that two of the worst hit Eurozone countries might not benefit from this new QE push as much as stronger economies will. This is because the ECB and the central banks of Eurozone countries will buy up bonds in proportion to its "capital key", meaning more debt will be bought from the biggest economies such as Germany than from small member states such as Italy. The latter country’s output has shrunk about a tenth over the last decade. In November 2014 Italy’s unemployment rate came in at 13.2% while the youth unemployment rate for those aged 15 to 24 rose to 43.3%. And Greece is still debating how committed it is to staying in the Eurozone, with the anti-austerity party taking the day. Whether Greece will stay in the currency union or leave, potentially triggering a debt default, is an open question. Should Greece decide to turn its back on Europe, it will do so too on the ECB’s asset purchase program.

Against this backdrop, the U.S. dollar has risen two handles since the ECB announcement. The U.S. Federal Reserve ended its own QE program in November 2014, with the focus now on commencing tightening. Look for the EUR/USD to trade at parity as the Eurozone has just embraced monetary easing. 

Outlooks and opinions included are those of the author and not necessarily RCM

About the Author

Jack Malone is a Futures and Options Advisor at RCM Asset Management with a focus on the metals and energy markets. Jack can be reached at jmalone@rcmam.com