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Does the FX Market Need an Intervention? - Global Exchanges

FICC Podcasts 19 avril 2022
FICC Podcasts 19 avril 2022


Disponible en anglais seulement

In this episode, we discuss the latest developments in the yen and euro and offer a bit of loose speculation ahead of this week's G7 and G20 meetings along the sidelines of the IMF/World Bank meetings.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:

Hi, welcome to episode 40 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. For this week's episode, my co-host Stephen Gallo and I will be talking about the latest developments in the yen and euro. We will offer a bit of loose speculation ahead of this week's G7 and G20 meetings that are along the sidelines of the IMF World Bank meetings. The title for this week's episode is Does the FX Market Need an Intervention?

Stephen Gallo:

Hi, I'm Stephen Gallo, a London based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York based FX strategist. I'm Stephen's co-host.

Stephen Gallo:

In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:

We strive to make this show as interactive as possible, so you don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates, or subsidiaries.

Stephen Gallo:

Okay, Greg, so we're going to get the ball rolling. This is episode 40. It's a nice round number of a milestone for us. It's the 19th of April, 2022, as we record. We often start these podcasts by looking at past returns. So for the relevant currencies, looking at the dashboard, the yen has fallen by an enormous 11% versus the dollar year to date. It's experienced a similar move against the onshore Chinese renminbi, the CNY, just a tad smaller than the move against the USD. Against the euro, year to date, the yen has fallen by 6%. In previous podcasts, we were discussing that the euro's fundamentals were as negative as the yens, if not more negative, but the move in the yen has been so severe that it's threatening to drag the Asian complex with it, despite jaw boning from various Japanese officials. And it's taken the attention away from the fundamentals in many other currencies. So given the scale of the move, the speed of the move, my first question to you, Greg, is do we have a real classic problem here in the FX market?

Greg Anderson:

Well, Stephen, with the way things have gone over the past two weeks, and particularly if the trends of the past two weeks continue, then I do think we have a problem. It's not a liquidity or market functioning problem because the FX market has held up really well in that regard.

Greg Anderson:

Look, to me, the biggest issue is that Japanese officials have lost the ability to steer their markets. On the rates front, we have the 10 year JGB yield, right back up to where it tests the BOJ's yield curve control upper boundary at 25 basis points. And then on the FX front, every form of verbal intervention known to mankind has been tried over the past week, including getting a perhaps reluctant BOJ head Kuroda to say that yen depreciation is excessive and unwanted, but that intervention has been basically ignored by the FX market.

Greg Anderson:

In my mind, when a central bank has lost its ability to steer markets, that's a potential problem. It would be an acute problem if it started to propagate out to other countries. And I like the way you phrased it, that perhaps we're on the verge of that with other currencies in markets in Asia.

Greg Anderson:

Look, it's hard to know if and when there will be, quote, unquote, contagion, but it's also painful to find out too late that contagion has occurred and the issue is rapidly spreading.

Stephen Gallo:

Okay, so losing the ability to steer the market, that sounds like we could be heading towards some type of misalignment in the yen. So with that in mind, what else can the BOJ really do at this point in time, Greg, to regain control over the yen?

Greg Anderson:

That's a really good question, Stephen. And the next problem is I don't really have an answer to it, and it would seem that Japanese officials don't either. The BOJ does have a policy meeting on April 28th and one thing they could do is surprise the market at that meeting. And I guess this part wouldn't be a huge surprise, but they could shift their 10 year JGB yield curve control mechanism. One easy thing, they could widen their band so that instead of the band being plus or minus 25 basis points around a center of 0.00%, they could widen it to something like 40 or 50 basis points. And in fact, they could even move the center of the band up maybe 10 basis points to +0.10% or something like that.

Greg Anderson:

But I guess I don't think that they would or could raise their overnight rate because they haven't done enough to prep the market sufficiently and it just might cause further instability. I hate to say it, but if we keep moving at three big figures a week, like we have the last several weeks, I mean, we could be at 133 in dollar yen by the time they get to that meeting. So I guess the other thing that Japanese officials can do to maybe calm markets in the interim is to phone a friend so to speak.

Stephen Gallo:

All right, so phone a friend, this to me is where things get really interesting, Greg. Now, I assume you're talking about coordinated intervention to strengthen the yen from Japan's G7 partners, but on that note, I've got a few brief questions. Firstly, as this move has been sort of induced by the BOJ rather than an external shock or some type of unforeseen natural event, do you think that means the G7 will approach this matter differently? Second question. What does the G7 have to gain by coordinating a response of this nature if it happens? And then thirdly, what will the G7 lose if it simply stands aside and does nothing?

Greg Anderson:

Okay, Stephen, I see what you're trying to do here. You're trying to sneak a bunch of questions into one, but I'll run with it. So firstly, I will partially take Japan's side and contest just a little bit what you said about this big move lower in the yen being induced by the BOJ. And what I would say is that the BOJ did not cause the supply chain problems that pushed US CPI above 8% and thereby forced the Fed to move extremely aggressively in 2022. Moreover, the BOJ didn't cause the massive repricing in 10 year government bond yields, nor did it cause oil to move from, we'll call it $70 a barrel in December to $110 in April. And that has massive implications for Japan's balance of payments and thereby puts downward pressure on the yen.

Greg Anderson:

However, what the BOJ admittedly did do, and it was a huge mistake in my opinion, is that as Kuroda waved the green flag for more yen weakness in his last policy meeting. In his press conference, he basically said that yen weakness was net-net good for Japan. Of course, that was with dollar yen at 118. When it hit 125, he changed his tune, but it doesn't entirely eradicate the first mistake.

Greg Anderson:

So on the topic of joint intervention, any parties to that, and I think I'll just add, mechanically, the way it has to work, the G20 is just too big of a body to participate. It would be done through the G7 and really mostly ECB, BOJ, Fed, Bank of England, those parties. At any rate, if we were to get to intervention, I think all the intervention participants would likely insist that Kuroda has to communicate in a manner that upholds the intervention's aims from there on. And then the BOJ would probably have to do something with its policy levers at that April 28th meeting.

Greg Anderson:

In terms of what the G7 would gain from intervening, that's got to be what they would ask themselves. And my answer is to go back to the pandemic analogy, so to speak. So at this stage, I would argue there isn't much visible contagion yet, but we don't entirely know what's happening underneath the service. And hopefully what's gained through intervention is it's an inoculation that increases the immunity of the global system.

Greg Anderson:

So your last question, what does the G7 or G20 lose if they do nothing? And again, they lose the opportunity to potentially prevent an outbreak. But I'll admit, it's hard to know either the probability or the severity of any outbreak that might occur so it's hard to answer that question in any way that's concrete. And that's probably why they don't do anything. When the situation is so unknowable, the easiest action is no action. So I guess with that in mind, I'd probably only give 20 to 30% probability ish to a joint intervention and I'll widen my timeframe just a little bit and say by the end of this month. But of course, if it were to happen, I think we'd see dollar yen back below 125 in an instant, and potentially back all the way down to 120.

Stephen Gallo:

Greg, that's great. Thanks for that analysis and also for quantifying the probability of coordinating an intervention at this stage.

Greg Anderson:

So now it's my turn to put you on the hot seat, Stephen. I get to ask you three questions about the euro. My first question is about the ECB. From the CFTC data, I note that IMM leverage funds moved to a net long euro position in the survey, and this is a survey taken last week, so two days before the ECB meeting and associated communications. Those euro longs have got to be a bit underwater now. So here's my question, why do you think the ECB chose to underwhelm relative to the market's expectations of hawkishness?

Stephen Gallo:

Okay, so for your first question, Greg, I'm not entirely sure it was a choice as much as it was a reflection of the difficult spot the ECB's in. Let's be fair, most central banks are arguably in a difficult spot in the current environment, between a rock and a hard place in many ways, but they at least have the luxury of being able to lay out some type of a roadmap for normalization. And we've seen that. The ECB on the other hand has a labyrinth to deal with because of the complexities of the euro area. And we don't need to go into these in this podcast, they're well known.

Stephen Gallo:

So if I can simplify things, the ECB can either follow other central banks, like the Fed, at a similar speed, or if it can't do that for operational reasons, it takes the gamble that moving slowly on normalization, even though the looks like the wrong decision now, it won't matter as much in six to nine months if we start to see real evidence of inflation falling sharply or weaker demand really starting to pull inflation rates lower.

Stephen Gallo:

But to answer your question, I don't know if it was a choice as much as it was a reflection of policy inertia and how large the split between the doves and the hawks within the governing council is at this stage.

Greg Anderson:

Okay, my second euro related question, if Marine Le Pen wins the French election this upcoming Sunday, April 24th, where does the euro go in response?

Stephen Gallo:

The simplest answer, Greg, based on FX investor positioning, which you briefly mentioned earlier, the trend in the polls since the first round, which I believe on balance have favored Emmanuel Macron winning in the runoff, I would argue that on a Le Pen win, we get a quick move to 104, spot reference 108, so four big figures purely on the shock of the result. But then I think we'd get a bounce, not a full retracement in my view, but some type of a bounce and consolidation. Do we get a move to parity in euro dollar on a Le Pen win alone? Probably not initially, in my view. What are the factors here for that call? Certainly plans for further fiscal integration into EU that would be delayed with a Le Pen presidency, because the block would basically have to try and find its footing again with this new type of presidency in France. The slow down or the slower pace of fiscal integration would probably make the ECB's job of normalization even more difficult.

Stephen Gallo:

But at the same time, Le Pen's sort of ditched the EU, ditched the euro membership for France platform from 2017, that's been toned down significantly. She significantly toned that down to try to win over centrist voters. And also, keep in mind, we have the elections to the French legislature due to take place in June, basically over the summer, near the summer. If the result there is not a clear win for her party, that could keep many of her ambitions in check. So a lot of moving parts here, it's not very straightforward if we get a surprise Le Pen win in the second round. Also, just keep in mind that before the second round runoff this coming weekend, we get a televised debate between the two candidates on the 21st. That could be a really key moment in this election. It certainly was in 2017 in favor of Macron.

Greg Anderson:

Okay, Stephen, we're winding down here. My last Euro related question, if the sanctions imposed on Russia are dialed up to more broadly include Russian energy, and so basically meaning if Europe stops buying Russian oil and natural gas, where does euro dollar go in response?

Stephen Gallo:

Greg, another good question in these highly uncertain geopolitical times, but again, on this one, there are so many moving parts here. Investor positioning in euro dollar doesn't suggest the market is anywhere near fully priced for this risk materializing that you asked about, even if the general weakness in the euro we've observed year to day is fundamentally justified by the balance of real flows. My point is that FX investors haven't ridden the tide of those flows by adding significantly to euro shorts, at least not in euro dollar.

Stephen Gallo:

So I would give you 103 as a target in euro dollar if Germany and the wider EU fully ban Russian energy imports, and I'm talking the whole thing, coal, lignite, crude oil, natural gas. My understanding is that less than half of Germany's energy generation comes from those fossil fuels. So it's not a cataclysmic event, but it's also a very sizable economic shock. On a move to 103, we may be getting to the point in the euro, which is close to where we said things currently stand in the yen now, but ultimately I think the euro's high liquidity profile reserve status, that would eventually provide a cushion to euro weakness. And still to this day, I wouldn't rule out some type of a response from the ECB to stabilize the euro.

Stephen Gallo:

On German growth this year, clearly a negative, but a lot depends on a number of unknown factors. What type of fiscal support will the government respond with? How efficiently will renewables be able to make up for the loss? How will the government ration the supply of energy? Given that we're moving towards the summer months, I suspect heavy industry will be prioritized over other sectors, but we just don't know. As for the ECB, makes an extremely difficult situation even tougher because the ECB would be faced with potentially an acute stagflationary environment, at least for time.

Stephen Gallo:

Rick, I think this is where we should wrap up episode 40. Thanks for your questions. Very interesting to get your take on the yen. Hope the same is true for my take on the euro. Thanks to our listeners. Join us again next time, please. All the best.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and research are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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