Are central banks on the verge of a currency war with the U.S?
That’s the question on the minds of some investors and economists as the U.S. dollar’s decline in the year has forced central banks across the world to intervene in their own currencies at the risk of attracting the scrutiny of the new Biden administration which is eager to support U.S. factories and create manufacturing jobs.
With policy interest rates for some central banks including the European Central Bank near zero, monetary policymakers are now trying to fend off an appreciation of their currencies to support their pandemic-battered economies and maintain the competitiveness of their countrys’ exports.
“Central banks are trying to stimulate their economies and reflate. But in an environment where demand is weak and rates are low, people will turn to the exchange-rate channel,” said Nathan Sheets, chief economist at PGIM fixed income and a former Treasury official in the Obama administration.
Other central banks, particularly those in Asia, with large trade surpluses needed an outlet to invest their hoard of savings, buying dollar-denominated assets and sometimes even buying other currencies outright.
BofA Global Research estimated a 4%-5% depreciation in the U.S. dollar would historically would see central banks’ holdings of Treasurys TMUBMUSD10Y, 1.170% rise by $160-$180 billion.
The ICE U.S. Dollar Index DXY, -0.55%, a measure of the greenback’s strength against its major rivals, is down 6.6% in the past 12 months, according to FactSet data.
Overseas central banks will be on their toes as more pro-labor constituencies in the Biden administration pressure the federal government to take a more aggressive stance to revitalize American manufacturers.
“The Treasury is going to be firm on countries that carry out interventions, especially to more sustained ones. The economic realities demand it, and the political realities demand it too,” said Sheets.
In Janet Yellen’s confirmation hearing for U.S. Treasury secretary, the former Federal Reserve chairwoman suggested she would take a dim view of other countries which move exchange rates away from market-determined levels.
The Treasury had labelled Vietnam a currency manipulator back in December. In addition, the Treasury has also placed China, Korea, Singapore, Taiwan, Thailand and India on their watchlist.
“Central banks in Asia are becoming concerned about rebukes and retaliation from the U.S,” wrote Shilan Shah, senior economist for Capital Economics.
It’s perhaps why some central banks including Chile and Sweden have started announcing in advance that they would start buying foreign exchange.
The Bank of Israel said it would purchase $30 billion of other currencies over the course of 2021.
Even if tensions between countries heat up over countries, some market participants say the U.S. Treasury Department won’t be able to match its bark with its bite.
The Federal Reserve and the Treasury have little experience intervening directly in foreign exchange markets to counter the actions of more proactive central banks.
“The stock line that the U.S. wants the dollar to be market-determined is just a stock line. It doesn’t really mean anything,” said Ed Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle Investments.
Al-Hussainy pointed to the example of the Swiss central bank as an indicator of the U.S.’s impotence. Swiss National Bank President Thomas Jordan has said U.S. criticism would not stop the central bank from buying more foreign exchange to fend off the currency’s appreciation.
“What are they going to do? Sanction Switzerland?” said Al-Hussainy, describing it as a “moment of truth” showing that the U.S. would struggle to impose their will on foreign central banks.
Problem go away with itself
And others said the potential tensions breaking out from increased foreign exchange intervention may sort itself out even without any actions from the U.S. Treasury Department.
“If I have to guess, I don’t think we will come to such a currency war, ” said Stephen Jen, who runs hedge fund Eurizon SLJ Capital, in e-mailed comments.
Jen anticipated U.S. economic growth would surpass the rest of the world as 2021 gets underway.
The U.S. government’s pandemic relief measures easily dwarfed the fiscal efforts by other governments. St. Louis Federal Reserve president James Bullard said it was possible U.S. economic growth could top 6% this year and outpace China.
By that point, the U.S. economy’s strength would make the trade boost from a weaker greenback less necessary.
“In that environment, exchange rate issues are less likely come to the fore,” said Sheets.