Global financial markets were up across the board on Friday-the S&P 500 up 2.5%, the Japanese Nikkei gained 2.8% and the Shanghai Composite rebounding over 3%.1 The Bank of Japan commenced a 20 basis point interest rate cut on excess reserves held at the bank. But it wasn’t just any rate cut- Japan lowered the interest rates on excess reserves on deposit to negative 0.10%.2 This increased risk appetites and sent investors around the world on a buying spree. Sovereign bondholders are actually paying interest to the governments to hold their bonds. Further, the Bank of Japan has says it has not ruled out additional rate cuts into further negative territory. In short, Japan wants people and institutions to spend or lend their money to stimulate their stagnant economy.
The predictable result is the Japanese yen depreciated roughly 3% against the euro and to its lowest level against the U.S. dollar in five weeks, at 121 yen per dollar. Also, the yields on 2-year British gilts (what they call notes or bonds) dropped so fiercely after the Bank of Japan’s announcement it’s causing some to speculate that the European Central Bank and other countries might be open to even more quantitative easing. Market participants are trying to figure out what is actually happening in the global economy.
The move aligns Japan with other countries who have also adopted negative interest rates, namely Switzerland, Sweden and Denmark. The European Central Bank also has a negative 0.30% rate for deposits, trying to spur lending and spending.
Why did the Bank of Japan lower rates?
Negative interest rates are the ultimate persuasion for lending money and taking risks because otherwise you pay to simply store money with the bank. But why would Japan want a depreciating currency? Because if your currency is too strong, it hurts exports since the buyers can’t afford to pay for the products with their [now] weaker currency. Also, trying to revitalize economic growth, Japan is actively promoting its tourism sector and a weak currency supports this mission. 13.4 million tourists visited the Land of the Rising Sun in 2015, a record.3 Japan has a goal of 20 million annual visitors by the time Tokyo hosts the 2020 Olympics. Now would be a great time to visit Mt. Fuji in Japan with the yen so weak against the dollar (121 yen per one U.S. dollar).4
Perhaps Haruhika Kuroda, the Governor of the Bank of Japan, felt forced to do something about the country’s slumping manufacturing, as another report yesterday showed a drop factory orders.5 Others speculate Kuroda was influenced by the dovish central bankers he mingled with at the Davos Convention of the world’s bankers in Switzerland.
Swiss National Bank
Switzerland is an appropriate spot for the conference because that is where one of the biggest currency stories of last year was regarding the Swiss franc. In 2011, the Swiss National Bank capped the Swiss franc at 1.20 against the euro during the European crisis.6 Last year, they abandoned the cap causing the Swiss franc to rally. The Swiss franc is seen as the ultimate safe haven currency by many since the country runs a balanced budget and has vast gold reserves. But it was strengthening too much and many Swiss stocks got hammered, especially exporters like Nestle. The Swiss National Bank currently has a 0.75% as its discount rate, trying to encourage growth.
Free Markets vs Managed Markets
Central Banks have the ability to intervene in currency operations. When countries don’t engage in a floating or ‘free market’ value of their currency, they peg, cap or fix them to another currency, often the U.S. dollar or the euro. Then they can buy or sell currency in the open market to maintain the peg ‘rate. Often, this is done by export-driven countries, who don’t want their currencies to strengthen too much. Some suspect that global Central Banks are engaging in a type of currency war, where the banks continue to depreciate their currencies, hiding behind the guise of spur growth or meet inflation targets.
The Blame Game
Others blame traders, speculators and hedge funds of manipulating the currencies or stocks. This week, China put out a warning for famed hedge fund manager George Soros to back off from shorting China’s currency and his “war on the renminbi”.7 Soros recently made comments that he was witnessing a hard landing in China. Last August, China lowered the renminbi parity rate, essentially depreciating the currency. We’ve seen instances of the Chinese arresting short-sellers of their stocks as well as outright bans on selling by some parties, trying to stem the rout in the Shanghai Composite.
Who is George Soros?
George Soros is well-known today as a financier and philanthropist, having allegedly given away $11 billion over his lifetime. But others call him the most notorious short seller in the world. Soros famously “broke the Bank of England” in 1992 by short-selling $10 billion worth of British pounds.8 Soros thought that the British currency, the pound Sterling, would have to be devalued because interest rates at the time were high and harming asset prices. His hedge fund, the “Quantum Fund” reportedly made one billion U.S. dollars on the trade. Soros made a similar bet during the 1997 Asian Crisis when he speculated against Malaysia’s currency. Now at age 85, he’s stirring up some trouble again and at the World Economic Forum in Davos he revealed that he was betting against ‘Asian currencies’.
China gave him a public warning that “Soros’ challenge against the [Chinese] renminbi and Hong Kong Dollar is unlikely to succeed. Soros apparently never mentioned which Asian currencies and some view this ‘slip’ by China as an appearance of vulnerability.9
Update your Passports
Of course, a strong currency is not all bad. If your home currency is relatively strong, it’s a great time to travel to countries with a weak currency and enjoy a bit of the good life. With the U.S. dollar, you’re certainly getting more bang for your ‘buck’ as the Dollar Index (a measurement of strength against a basket of other currencies) is reaching levels around par (100).
For more adventurous travelers, consider hitting some emerging market currencies. How about an African safari? The South African rand last lost over one-third of its value against the U.S. dollar.9 Maybe a cocktail on Copacabana beach in Rio? The Brazilian economy is faltering and the Brazilian Real has lost roughly 70% of its value against the U.D. dollar in a little over a year. It now stands at 4 Reals per one dollar, a level last seen around 1994.10 Analysts at Standard & Poor’s cut their rating on its sovereign debt to ‘junk’ last year, exacerbating the problem.
As long as Central Banks continue to intervene in the currency markets, in conjunction with government policies, we will see whipsaw moves for foreign exchange markets and equity markets. If the global growth story turns sour, there will be the need to watch for the coming currency wars.