Are we facing the prospect of a Currency War?


Currency wars’ seem to be the flavour of the month, with the upcoming G20 meeting likely weighing heavily on market sentiment. It is generally a fancy term used to describe a country’s intention to devalue its own domestic currency. Countries may want to do this in order to reduce the price of their exports, which would indirectly help to benefit domestic manufacturing, as well as stimulating employment and growth. While not officially disclosed, the topic is certain to be on the agenda among the dignitaries in Moscow for the G20 meeting.

Those nations with developing economies are likely to be the chief accusers of the largest developed economies and their nations trying to manipulate their currency. In a pre-emptive defence, the G7 nations announced on Tuesday that they assure they are not targeting exchange rates. The announcement also comes in the wake of some recent volatile movements in the Forex markets. The G7 group were quoted as saying they would “consult closely” on any action in the currency markets.

Primarily in the firing line are Prime Minister Abe and the new Japanese government, who have made a number of references in recent months about the Yen’s strength specifically. All the G20 nations will no doubt understand Japan’s wish to stimulate its economy after 25 years of stagnation, but they would equally be aware that constant reference to Japan’s currency leaves little to the imagination about how Abe and his yet to be announced Bank of Japan governor are planning to spark this economic stimulation. The US treasury has added its weight to the prospective intervention with a thinly-veiled statement:

…for the market process to work, exchange rates must be allowed to reflect market forces.

In the eyes of the G7, a more acceptable use of domestic economic policy has long been the cutting of interest rates. The US, UK and the European Central Bank rates are all at record lows, but none lower than Japan. The Japanese rate has been stuck at 0% for some time, so they literally cannot cut further. It’s unlikely, therefore, that the Japanese government is going to heed much warning about its prospective currency devaluation, as it could legitimately argue the point of: what choice does it have? With such a strong intent, any words by the G7 will likely fall on deaf ears for both Japan and Forex traders, whereas a more concrete G20 announcement, despite it being unlikely, may have more of an effect.

There is a case to be made that the surrounding talk and speculation on the Yen by the G20 countries is actually helping to the Yen to drop more than any BoJ policy or market sentiment. Stopping the chatter might stop the rot, as it were.

There are signs in the market that the risk appetite is creeping back in, while the Euro Zone looks to be making a (painfully slow) crawl to prosperity. With this in mind, the EUR/JPY pair could continue to rise and test the 130.00 level in the coming days and weeks. Lest we forget, however, that the pair was at 94.00 not more than seven months ago, so be prepared to curb your enthusiasm.

But I expect EUR/JPY in particular to remain bid and any dips short lived in the short term, with 125/130 on FX trading platforms an “acceptable” range with the damage from yen comments already done and unlikely to be retracted.