Earlier this year, we saw a transition from an old-style currency war (openly fought with negative interest rates and quantitative easing) to the “Shanghai co-op” – an implicit agreement, or truce, among major central banks that excessive dollar strength was bad for the global economy. As a consequence, the Federal Reserve became more dovish, the European Central Bank (ECB) and the Bank of Japan (BOJ) de-emphasized negative interest rates, and the stabilization of the U.S. dollar helped emerging markets and commodity prices recover. Also, China’s depreciation of the yuan was orderly rather than disruptive.
With Donald Trump’s election as U.S. president, we have entered a new phase that I call a “cold currency war.” It’s a cold war because central banks are fighting in a more guarded way.
- Even before the U.S. election, Japan was moving subtly in the direction of further currency depreciation. By pinning the 10-year Japanese government bond yield near 0% since September, the BOJ has managed to widen the yield differential between Japan and the rest of the world during the global rates sell-off of the past few months, which has beautifully depreciated the yen. Following the BOJ’s meeting this week, Governor Haruhiko Kuroda said it was too early to change that yield target and downplayed yen depreciation (noting it was only back to where it had started the year).
- The ECB implemented a “stealth rate cut” in early December by dropping the deposit floor for bond purchases, which helped to push the euro lower.