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Swiss Bank cautious over Swiss Franc

Discussion and Analysis by Charles Porter:


This morning, Switzerland’s National Bank (SNB) issued a press release detailing their latest monetary policy assessment. Their report detailed that the SNB is “maintaining its expansionary monetary policy”. Because the Bank had previously adopted negative exchange rates, this has interesting implications for macroeconomic thought as well as the Swiss macroeconomy.


The decision to adopt negative interest rates in Switzerland was a surprising event in itself. Naturally, therefore, the decision to retain negative interest rates once again qualifies this decision and leads us to continually re-evaluate our macroeconomic thinking. To explain this and frame the analysis upon currency markets, I will briefly discuss why negative interest rates are a problem. Following this, I will discuss why a consideration of our macroeconomic assumptions is advisable.


Interest rates should never and can never fall further than zero; at least that’s what a lot of people thought before it happened. The logical underpinnings of this longstanding macroeconomic assumption are mostly theoretical. This theoretical truth thereby became an empirical truth by the unwillingness of central bankers to challenge the hypothesis.


However, in the wake of the financial crisis, hyper-low interest rates simply weren’t enough to stimulate the economy. The spill-overs associated with Quantitative Easing, hyper-inflation, asset-scarcity and crowding-out, and the unpredictable and slow nature of expansionary fiscal policy, provided the impetus to plunge through the Zero Lower Bound.


It is theoretically upheld that interest rate policy cannot break the zero-lower bound, i.e. interest rates cannot become negative. The theoretical underpinnings of this claim are coherent and pervasive. The central mechanism preventing negative interest rates is derived primarily from the effect upon savers. Rational individuals who hold money, even for a short period of time, within a bank account will, in theory, choose to withdraw their money from bank accounts and hold it in non-interest-bearing cash instead. Therefore, the cash deposits that banks create leverage upon in order to extend credit to consumers and investors alike will be eliminated entirely. There will, therefore, be a liquidity trap assuming that the private banks’ reserve requirements are not equal to zero.


Given that the Swiss National Bank has not only delved into negative interest rate territory but stayed there for another month, the zero-lower bound hypothesis may, after all, be a fallacy. The reassurance given by the considerable longevity of negative interest rates in Switzerland may, perhaps, be due to a public unwillingness to assume the risk of withdrawal and perceived lack of security.


Therefore, because the ‘under the mattress’ alternative has considerable costs of its own, a moderately negative reward to holding liquid currency is still seen as a worthwhile quasi-expense. Therefore, after all, because the ultimate purpose of negative interest rates is to prevent individuals from holding idle money and instead increase consumption and investment, it is possible that the velocity of money circulation within the economy has risen.


During the National Bank announcement, the value of the Swiss Franc was highly volatile. However, the direction of change was almost imperceptible, with high amplitude movements around the pre-announcement rate. After several minutes, markets reacted to the news as well as global macroeconomic environment and political risk by devaluing the Swiss Franc considerably.



Skyscraper view

The State of the European Union

Discussion and Analysis by Charles Porter:


This morning, before the European Parliament, Jean-Claude Juncker, president of the European Commission, gave the annual State of the European Union address. Juncker’s speech gave a daring and interesting presentation of the present and future state of the Union. A number of interesting events and currency movements arose from this speech. Specifically, two polarised references to Turkey are analysed within this article.


Juncker’s dichotomous comments regarding Turkey centred upon, firstly, the nation’s support surrounding the European migration crisis. The second concerns Turkey’s accession prospects.


The European migrant crisis has been curtailed thanks to the agreement with Turkey, Juncker explains. The consequences of this deal include a control over the loss of life within the Central Mediterranean route and a curtailment of the pressures upon boarder forces within the EU’s periphery. This could seemingly be confused for support of Turkey’s European role and progression of accession prospects. However, Juncker’s second mention of the nation was far more damning.


Turkey first applied to join the-then European Economic Community in 1987. Following the millennium, however, it has seen what is best described as stagnant, if not receding, progress. This empirical truth remains despite the commencement of formal negotiations in 2005. Today, the State of the Union address cemented this fate. Referencing the centrality of European values within the accession negotiation procedure, Juncker stated firmly that EU membership is comprehensively ruled out “for the foreseeable future”.


The currency market reaction to this proclamation from the Commission president will provide an indication of what degree of strength, if any, the Turkish economy derives from its prospective membership and integration within the European project.


Interestingly, not only was the Lira highly stable in the immediate aftermath of President Junker’s remarks but the intraday differential within the Euro-Lira exchange rate was negligible. Whilst there was considerable volatility within the currency pair, this was in no small part due to the tumultuous episodes the Euro itself experienced today. Because derogatory remarks about the socio-political complexion of Turkey’s incumbent government did not destabilise the Lira it may suggest that the possibility of accession, despite formal application, was never considered credible by currency markets and thus never priced into the Lira’s currency pairs.


Alternatively, yet perhaps less likely, it may suggest that the net economic benefits of membership are negligible. This event is important because it could, in theory, have represented the manifestation of an idiosyncratic, niche, reshuffling of a currency’s valuation. Given Juncker’s positive comments today regarding the credibility of Balkan state accessions, the two divergent hypotheses above might be analytically testable in the future.



Early Morning UK Trading

Discussion and Analysis by Charles Porter:

Sterling has opened high once again this morning. Since the start of the month, sterling has gained value, now reaching the highest rate against the Dollar for over one year. Sterling now trades around the value it did in the immediate aftermath of the Brexit decision. We analyse why and whether this is sustainable, grappling with the early morning trading prospects of today.


Sterling rose strongly across the board yesterday on the back of lofty inflation statistics. We published a two-part article examining the relationship between exchange rates and inflation with particular attention to the dynamics behind Sterling currency pairs. Whilst the revaluation of Sterling is logically explicable, its longevity must be questioned, at least for the immediate future.


The inflation rate spurred an increase in Sterling-based exchange rates in anticipation of the emergence of a more hawkish monetary policy decision from the Bank of England on Thursday. However, an obstacle to a more divisive or even hike-favouring vote will arise today. Later this morning, UK employment statistics will be released. Crucially, average earnings and the rate of wage growth will be discernible from the data.


The Bank is unlikely to vote in favour of a rate-hike if wage growth remains low. This is because the real income of UK citizens would likely be suppressed further, generating a headwind over the short-medium run for employees and consumers alike. Therefore, price inflation concerns may be subdued given that the rest of the macroeconomy is not performing well.


This morning’s statistics release will therefore contain the propensity for a development of the revaluation, or, a deterioration of the recent value that Sterling has gained. If wage growth statistics paint a pessimistic picture of the UK labour market then gains within the Pound will be eroded. In this scenario, the market would revise the future probability for monetary policy tightening downward, weakening the Pound.


If wage growth is strong, the CPI inflation statistics released yesterday gain further bite in their capacity to indicate the need for a monetary policy tightening. Within this scenario, Sterling’s gains would be bolstered and enhanced. There is considerable upside risk being attested to within wage and employment data which, if verified, will lead to an intraday revaluation of Sterling based exchange rates. If the transparent decision tomorrow does not verify this market impression then all gains made yesterday (and perhaps today) will be eliminated.


Ultimately, a lack of confidence in a rate hike tomorrow is what we believe is pragmatic and realistic. However, it is plausible that even one more vote endowing the support for a rate hike is enough to sustain, if not improve, Sterling’s gains. Given recent speeches of Monetary Policy Committee members in favour of an immediate 25bp hike, we can confidently assert that the specific development of the macroeconomy ensures their continued support for a tightening tomorrow. With this in mind, we look towards the employment data releases and monetary policy decision with scepticism.



SGM-FX View of london

UK CPI Inflation – Part Two

Discussion and Analysis by Charles Porter:


PART TWO: Inflation data and the United Kingdom


This morning saw the monthly release of salient macroeconomic data related to prices and inflation. Each major GBP-based currency pair has experienced a rally following the release, leading to an explicit appreciation of the Pound Sterling. This article analyses the market mechanisms behind the revaluation.


Part One of this article examined why higher than anticipated inflation rates lead to a counter-intuitive appreciation of the exchange rate in favour of the Pound Sterling. However, an expectation-based currency appreciation such a this connotes complications and urges caution. This article explicates these worries, presenting a cautious and bearish impression of Sterling’s week ahead.


Firstly, the longevity of the heightened inflation must be questioned. Secondly, the policy preferences of the BoE should be qualified. These two admonitions are explained sequentially below.


Why might inflation not last?


Inflation, when measured by both indices, is a reflection of the weakness of Sterling induced immediately after the Brexit vote on 23rd June 2016 and related downward trends. The weakness of the pound decreases the international purchasing power of the pound meaning that imports are relatively more expensive. The Retail price index increases due to expensive import components used within the production process, whilst the CPI is inflated because imported consumer goods, with a price fixed in an international currency, cost more pounds.


Given that well over one year has elapsed since the decision, the year on year percentage change in the index value will begin to adopt a new threshold of base rate. Specifically, that base rate will begin to be one that was itself affected by the weaker pound and higher inflation. Whilst there is a delay in the sensitivity of inflation to the exchange rate and import prices, excessive year on year inflation should be short lived. Thus inflation will begin to retreat back to BoE targets.


If the BoE internalises the purely short-term nature of the inflation rate then it is more likely that the Committee will vote against a rate hike in order to prevent the loosening of monetary policy once inflation rates have normalised. Therefore, in summary, the excessive inflation rate does not represent an economy with no spare capacity overheating. Instead, it portrays an economy with a high marginal propensity to import struggling to adjust to accelerated import prices.


The Bank of England Committee:


The second admonition alluded to above is the Bank’s set of policy preferences. Some members of the Committee are evidently more hawkish than others, having voted consistently for a rate hike during previous meetings. Others, however, may adopt more cautious, dovish, policy paths given the stagnation, or even inversion, of real wage growth.


Raising interest rates should curtail investment by raising the cost of borrowing. As investment falls alongside the availability of capital, the propensity for progression and wage growth similarly falls. Therefore, an interest rate hike may further stagnate real wage growth. The mandate of the Bank permits this consideration because it is less independent when measured by policy than, for example, the ECB. Therefore, considerations outside of the rate of inflation and price stability are permissible, increasing the propensity for a no-hike decision despite today’s data.


In conclusion, today’s data may only really represent the weakening of the purchasing power of one unit of British Sterling. Considerations of the Bank’s likely action may preclude the expectations that have now, after 9:30AM, been priced into the exchange rate from materialising. There is therefore a downside risk within GBP-paired currencies. Accordingly, there is an acute possibility that Thursday will see a reversal of the gains made against the Dollar and Euro today. With employment data released tomorrow, there is also the possibility that Sterling’s strength might be even shorter lived. The informal rhetoric surrounding the Bank’s monetary policy decision will be just as important for exchange rates as the actual interest rate target. This is because confidence may be induced for future, imminent, rate hikes thus preserving Sterling’s new exchange rate.



The Graphs above show the Sterling-Euro and Sterling-Dollar intraday exchange rate fluctuations. The CPI data was released by the ONS at 09:30 this morning. A clear spike coincides with this time because expectation-based mechanisms manipulated the clearing rate of the two pairs of currencies. Following the decision, Sterling continued its gains against the international reserve currencies throughout the morning.

SGM-FX View of london

UK CPI inflation – Part One

Discussion and Analysis by Charles Porter:


PART ONE: Inflation data and Exchange Rates


This morning saw the monthly release of salient macroeconomic data related to prices and inflation. Each major GBP-based currency pair has experienced a rally following the release, leading to an explicit appreciation of the Pound Sterling. This article analyses the market mechanisms behind the revaluation.


The Office of National Statistics (ONS) released a series of Macroeconomic data this morning. Data included the headline Consumer Price Index (CPI) alongside the Retail Price Index and various breakdowns therein.


The paradox this morning is that inflation exceeded expectations and, in absolute terms, was exceptionally high, however, the exchange rate appreciated. The ONS this morning published a CPI inflation rate of 2.9% year on year for the month of August. With the Retail Index similarly beating market expectations, the inflation picture for the UK economy is concerning. Inflation statistics measure the rise and acceleration in the domestic (and international) price level and (deteriorating) purchasing power of the national currency. So, if inflation rises, then the value of each unit of the domestic currency over the given period has decreased.


If an increase in inflation is anticipated, it will be factored into the market exchange rate through an expectation-based manipulation of the clearing rate of supply and demand. Current investors and holders of the currency will wish to limit their exposure to the domestic currency and thereby increase the money supply upon their exit. In contrast, those prospectively looking to hold the currency will look elsewhere due to fears that inflation will erode their returns. This reaction reduces the demand for the currency. The two forces mutually reinforce to decrease the clearing price and parity of the currency against international counterparts.


If inflation is unexpected, investors will be tempted to limit or eliminate their exposure to the currency, similarly increasing the supply, whilst the demand falls. When inflation is unexpected, the adjustment is more instantaneous as ‘hot’ money flows surge around the economy. So why did the exchange rate appreciate so rapidly in favour of the pound (and not depreciate) following an inflation report that showed the price level accelerating at rates above target inflation?


Once again, extending the theme of the past few weeks, central banks hold the answer. The Bank of England (BoE) is set to decide on monetary policy following a Committee meeting on Thursday. Sterling’s appreciation today stems from the pricing in of a Hawkish prospective monetary policy decision. With a 6-to-2 divide following the last monetary committee meeting, investors’ hopes for a further division and a movement closer to an affirmative rate-hike decision shifted the exchange rate.


Whilst the base-case and expectations across the market remain with a no-hike decision, the central price inflation mandate is being threatened. Curtailing inflation through a tighter set of monetary policies therefore seems more likely. Monetary tightening through the curtailment of quantitative easing or raising of interest rates traditionally, and logically, appreciates exchange rates. By decreasing the central bank’s extension of the money supply and increasing the rate of return to investment respectively, the equilibrium exchange rate should rise. The increased probability of a monetary policy tightening is what the graphs below and Sterling’s appreciation reflects.



The Graphs above show the Sterling-Euro and Sterling-Dollar intraday exchange rate fluctuations. The CPI data was released by the ONS at 09:30 this morning. A clear spike coincides with this time because expectation-based mechanisms manipulated the clearing rate of the two pairs of currencies. Following the decision, Sterling continued its gains against the international reserve currencies throughout the morning.


Part Two of this article examines why the appreciated exchange rates following this morning’s statistics release may not be sustainable, creating doubt over Sterling’s rediscovered strength.



Niche Opportunities in Foreign Exchange

Discussion and Analysis by Charles Porter:


Unexpected events that are endogenous to currency systems and the macroeconomy are difficult to forecast accurately. However, their manifestation generates considerable risk and volatility; phenomena to either seek or eschew dependent upon individual intentions and approaches to risk.


This article covers recent developments within Uzbekistan’s Som and the Chinese Renminbi.


The Uzbekistan Som:


Uzbekistan gained formal independence from the former Soviet Union in 1991. As the national sovereignty and independence of the nation matured, the calls to generate a more equitable and market-based system have grown stronger. This progression has been enhanced by a turnover of state office from the non-contested long-standing leadership of Islam Karimov last year. Since the millennium, prices have become gradually less stable and have followed an almost exponential-looking curve.


Whilst a market-based system may be argued by some to create an inequitable and exploitative system, flexible and floating exchange rates are certainly an inherent characteristic of capitalism. The equitability of flexible exchange rates means that a clearing rate of a currency’s supply and demand will determine the international parity of exchange rates. Therefore, equitability is derived from the non-state determined privileging of importers over exporters.


The peg to the United States’ Dollar has been gradually weakened, allowing the equilibration of the exchange rate to take hold slowly. This reduces any sudden shock to the economy and allows individuals and citizens to adjust to the change. However, last week, a complete cessation of the Uzbek central bank’s support occurred. This lead to an intraday, immediate, depreciation of the exchange rate against the US dollar of almost 50%.


Pegged exchange rates are becoming less and less common due to a one-way entropy; almost a telos of capitalism. However, when a peg is either initiated or released by the actions of a government and central bank, extreme currency market fluctuations are likely to prevail. Opportunities to exploit such changes are apparent, however, the concealed and secretive polities within which they occur usually insulate any discourse that would reveal unpegging intentions.


The Chinese Renminbi:


A polarised story has unfurled within the Chinese Renminbi. There are accusations that the value of the Chinese currency is unfairly and artificially suppressed. The suppression of the value of the Renminbi should make domestic (Chinese) exports appear more competitive by reducing their nominal value within other currency systems. This does have the effect of raising the price of imports, however, should the marginal propensity to import be low, outflowing capital controls be high, or a domestic economy be self-sufficient, the trade-off that the aggregate economy faces may lean in favour of a depressed currency.


A persistent strengthening of the Reminbi against the Dollar in recent months has undermined China’s exporting-stimulus. This trend was insured against by increasing the capital requirements of institutions holding short forward (downwards speculative) trades within the Renminbi. This effectively makes the duration within which the forward trade is held more expensive to the firm or individual holding the right to it.


In the final trading hours of last week, two conjoining state rules aimed at preventing negative speculation were dropped. This made capital outflows and speculation more attractive, thereby inducing a sharp spike in the USD/CNY exchange rate. Specifically, we saw a weakening of the Renminbi by around 0.8% almost instantaneously.


The retraction of these requirements induced two opposing currency forces. Firstly, favouring a strengthening of the currency, it signalled the end of state fears of capital flight and speculative currency depreciation. Secondly, and inversely, it facilitated capital flight and speculation, threatening to devalue the Renminbi. The net effect was a devaluation, which is not necessarily harmful to the Chinese economy for reasons mentioned above.


Regulatory loosening and the removal of capital requirements for downside speculation partially liberalises the exchange rate to move freely. However, the currency reserves of the Chinese central bank suggest that the power to restore and stabilise the currency at a given level is immense. These kinds of change provide opportunities to capitalise upon exchange rates that are, however, difficult to predict and sometimes entirely unforeseeable.



The spike in the exchange rate is visible immediately before the end of trading hours on Friday. The upward spike represents a strengthening of the US Dollar and weakening of the Chinese Renminbi in excess of 0.77%.



Natural Uncertainty Amidst Geopolitical Insecurity – Part 2

Discussion and Analysis by Charles Porter:

Natural uncertainty amongst geopolitical insecurity: Part Two.

Whilst the media has abounded with talk of a risk off environment precipitated by numerous central bank announcements and geopolitical threats, natural disasters are embedding themselves upon our radar. Our thoughts and concerns truly rest with those affected, either directly or indirectly. This article addresses the financial legacy and currency purchasing power that those emerging from these terrible natural geographical events will awaken to. This article tests the hypothesis generated within Part One.


Wednesday 23rd August marks the date of the declaration of a State of Disaster across endangered regions of Texas. This was a pre-emptive move in order to convey the severity of the tropical depression and the need to prepare. Despite the potential for currency speculation and risk management before this date, we should expect this date to mark the active pursuit of hedging against threatened asset exposure. Therefore, the logic expounded within part one would dictate that a deterioration in the value of the United States’ Dollar (USD) should coincide with this date.


In the stacked graph above, we analyse this event within the Dollar against the Great British Pound (GBP) and, below that, the Euro. Within the two graphs, the vertical orange line demarks the State of Disaster declaration with the corresponding yellow line marking the manifestation of the damage following the depression’s landfall. Thus, between the orange and yellow lines, the value of the USD should deteriorate.


Clearly, this expectation is empirically validated. However, in order to justify this explanation, the ‘ceteris paribus’ condition must hold. Therefore, there should not be an alternative event that could be reasonably attributed to either a devaluation of the USD or a simultaneous revaluation of both GBP and the Euro.


Undermining this trend’s support for the storm hypothesis, there are many notable events within this time period. Most importantly, two speeches on the 23rd and 25th of August generated strong rallies within the Euro. Both of these events spurred the value of the Euro considerably. Within the lower graph, therefore, the inter-marker volatility is at least in part attributable to the Euro, not the USD. Draghi spurred the Euro during these speeches by praising the Quantitative Easing program and choosing not to attempt to talk down the currency and arrest is sustained appreciation.


Similarly, the latter of these two speeches saw Janet Yellen, Federal Reserve Chair, precipitate a mild depreciation of the USD. Yellen’s effect upon the USD permeates across most currency pairs including the GBP and the Euro. Therefore, the mutual reinforcement of central banker announcements could be confused for the artificial verification of the natural disaster hypotheses. Furthermore, the broad risk off environment induced by the 25th August North Korean aggression and missile tests, lends further reasoning to a USD devaluation within this period.


Regarding the expectation following the storm’s impact, the affected currency should regain strength. As argued within the previous article, this is due to the repatriation of funds following from insurance claims and a re-equilibration of the investment potential and concomitant clearing exchange rate level. Again, this expectation appears to have been met, particularly within the Euro. Within the GBPUSD pair, the expectation is not completely undermined. Instead, the exchange rate appears to be more static.


Analysing the mechanisms behind these trends reveals that similar events over this period could explain the Dollar’s re-appreciation without reference to the repatriation of post-Harvey funds. Most notably, this period saw the second reading of US annualised second quarter GDP growth revised up to 3.0%. However, the general trend does lend, albeit qualified, support for the storm hypothesis as an underlying mechanism behind USD valuation.


Let us now turn to the powerful Mexican earthquake that struck in the early hours of this morning for an indication of the effect of an unforeseen natural disaster upon exchange rates.



Figure Two: The Euro – Mexican Peso exchange rate. The earthquake tremor registered at 05:49 BS.


The hypothesis clearly appears to be verified. Capital flight caused by the uncertainty derived from the natural event clearly manifests. This weakens the Peso against the Euro, generating an exaggerated spike. With time, the exchange rate appears to normalise back towards pre-tremor levels. This highly short-term view validates the unforeseen natural event hypothesis. Soon, we will be able to test whether a repatriation of insurance funds within the domestic economy will lead to an appreciation of the Peso given more time. The effect within the Peso this morning may have been moderated by the proximity of the event from the capital, Mexico City.

Natural Uncertainty Amidst Geopolitical insecurity

Discussion and Analysis by Charles Porter


Whilst the media has abounded with talk of a risk off environment precipitated by numerous central bank announcements and geopolitical threats, natural disasters are embedding themselves upon our radar. Our thoughts and concerns truly rest with those affected, either directly or indirectly. This article addresses the financial legacy and currency purchasing power that those emerging from these terrible natural geographical events will awaken to.




The North American continent has been subject to severe natural disasters over the past couple of weeks. The United States is now recovering from hurricane Harvey and Mexico this morning incurred a record breaking, catastrophic, earthquake. Looking forward, Florida braces and prepares for what appears to be an immense hurricane, potentially Category 4, ‘Irma’. We discuss the logic of natural disasters upon the exchange rate and then, in a subsequent article, test these hypotheses to identify whether these trends are perceptible within empirical charts.


Expectations regarding natural disasters, such as those described above, can be divergent. For example, if the natural disaster is forecasted, such as the forewarning of a hurricane, the concomitant expectation, ceteris paribus, is for a devaluation of the affected currency. This is because investors or individuals with liquid assets held or exposed within the threatened geography, will attempt to limit, or eliminate entirely, their exposure to the disaster. The extent of the capacity for the reallocation of assets will depend upon the very nature of the assets. For example, if the elasticity of a particular national product is highly inelastic, particularly if there are few substitutes, the depreciation effect will be necessarily diminished.


The overarching mechanical expectation behind a currency devaluation preceding the impact of a natural disaster (post-forecast) is an increase in the supply of money, assisted by a decrease in the demand for it. The supply increases whilst investors and individuals attempt to liquidate exposed assets in favour of others, likely denominated in another currency. Money demand would likely be comparably reduced through similar actions of prospective investors, delaying or reorienting their investments. The clearing rate of the affected currency pairs should therefore precipitate a weaker affected currency.


For an unforeseen natural disaster, such as that which has hit Mexico overnight, there is no warning time and thus no pragmatic flight of capital. Given that investors will have few available options to liquidate their assets, particularly if the incident occurs at an adverse hour, we might expect the currency to continue to trade closer to its previous rate. This is because both the demand and supply of the affected currency is unlikely to relatively fixed in the ultra-short, immediate, term. However, whatever assets are liquid and whatever capital is active to speculate against the currency, will be used to result in smaller, unstained, movements around the time of the crisis.


In the days following the incident, however, the value of the affected currency may be thought to increase for two reasons. Firstly, insurance flows following the disaster may amount to a sizeable repatriation of the currency. These flows, comparable to the order of the damage and thus severity of the natural disaster, will create a force that attempts to restore and increase the strength of the domestic currency. Secondly, the fear and worst-case scenario character of risk evasion from a natural disaster may suggest a bias towards an excessive pre-impact devaluation. Therefore, once the damage to the economy becomes known and more tangible, the eschewment of the affected currency should end. This will restore a significant portion of the demand for the domestic currency.


There may, however, be a counter-force to this currency revaluation. If the response to the crisis comes not from externally denominated reserves, but from governmental new state money, then the currency supply should de facto increase. This axiomatically reduces the strength and purchasing power of the currency by pushing down the clearing rate of the supply and demand for the currency. If, instead, foreign reserves are sold off in order to purchase aid in the domestic currency, this effect can be inverted. Although uncommon, this option has been invoked in the past.


Part Two of this article tests the hypotheses generated within this article.

ECB Monetary Policy Decision

Discussion and Analysis by Charles Porter:


Mario Draghi, President of the European Central Bank (ECB), offered a cautious and Dovish press conference following today’s monetary policy decision. This decision saw all three headline monetary rates remain constant, whilst net asset purchases were maintained at €60bn. This article analyses the market’s reaction to this move in addition to the new European macroeconomic impression that has manifested following this conference.


Immediately below, we present a chart of the performance of the Euro against both the United States Dollar (USD) and the Great British Pound (GBP). The graphs show considerable appreciation of the Euro following the press conference at 13:30 BST, the duration of which is marked with a horizontal black line, and a moderate devaluation following the decision release demarked by the vertical line.



The graph above shows the EURUSD exchange rate above the GBPEUR rate. The apparent inverse correlation between the two charts shows that the causal influence, unsurprisingly, lies within the Euro and thus the ECB’s actions.


We live tweeted the progression of Draghi’s press conference on our twitter site. The set of prospective key announcements that would have appreciated the Euro included an announcement of the immediate or planned tapering of the asset purchase plan, Quantitative Easing (QE). Alternatively, because forecasts were released simultaneously within the press conference, an increased forecast of either inflation or economic growth would have rallied the Euro.


What would have depreciated the Euro against these major currency pairs is an active and clear attempt to talk down the currency. Draghi may have had an incentive to pursue this option due to the deflationary pressure that the sustained and rapid appreciation of the Euro has generated within the Eurozone.


Ultimately, in contrast to his recent Jackson Hole and Lindau speeches, Draghi did make reference to the exchange rate. However, the Dovish stance towards the exchange rate were clearly insufficiently grave in order to either worry investors or deter from the forward planning advice that the decision also contained. Live analysis, however, did identify investors’ fears for a split second when the topic arose.


Instead of condemning the Euro’s strength, Draghi instead signalled that whilst a plan was not yet in place, the QE program would remain throughout this and the next year, with further details on tapering likely to be released in October. Confidence in the gradual tapering and eventual cessation of the asset purchasing program attracted capital to the Euro, thereby increasing its relative value.


QE, often alluded to as the printing of money, involves the purchasing of assets by the central bank in order to stimulate the economy. The purchase with new (but not printed) money raises the aggregate money supply, M3. Given that an exchange rate price level is equal to the rate at which supply and demand clear or equilibrate, QE is clearly responsible for artificially constraining the value of a currency. Therefore, plans for its curtailment or withdrawal signals to investors the likelihood of a future increase in the currency’s value. This signal generates an expectation of future value enticing investors to purchase the currency (and assets therein). The money demand therefore increases, raising the price level in anticipation of the impending constraint upon the money supply.


The current program of QE ends with 2017, therefore, a new plan must be generated in order to facilitate the continuation and eventual tapering of QE. Given that the ECB only has two scheduled monetary policy decisions remaining between now and 2018, either one of these meetings must present a finalised asset purchasing program. Draghi alluded to October as the meeting within which the majority of arrangements should be formalised and presented.


As the Euro continued to appreciate during the press conference, the pressure on Draghi and the ECB to counteract spill-over dis-inflationary pressures and the deteriorating competitiveness of Eurozone export will rise. Therefore, whilst for now Euro-strength only creates a “broad dissatisfaction tempered by the confidence that inflation will eventually converge”, markets will debate the risk of a future backlash against the Euro’s strength. For the immediate future, however, positive sentiment supplemented with positive future economic forecasts paves the way for a strong Euro.




Unanticipated Rate Hike

Discussion and Analysis by Charles Porter:


Despite defying the dominant market opinion, and with inflation trailing well below a 2% target, the Bank of Canada raised their interest rate target by 25 basis points. This article analyses this move in the context of the global political economy and the viewpoint of the Bank of Canada.


Given the predictable effects upon the exchange rate, and the spill-over effects therein, a hike decision was forecast neither by our previous analysis, nor by the dominant market perception. An analysis prioritising a logic of exchange rates led the previous article, and market analysts alike, to a no-hike conclusion. Interestingly, despite the Bank claiming to give a privileged consideration to the power of the domestic currency, the foreseeable exchange rate effects appear to have been forgiven.


The overwhelming motivation for the interest rate hike from the Bank of Canada this afternoon was economic growth performance. Specifically, as we alluded to within our previous article, Gross Domestic Product (GDP) statistics released last Thursday guided the rate hike. As the second consecutive rate hike of 2017 to the tune of +0.25%, following a duration of 12 months fixed at 0.5%, the decision certainly leads momentum to sentiment of global economic recovery.


Intraday movements of Canadian Dollar currency pairs showed sharp volatility. In order to visualise and analyse this event, the intraday graph is provided and described below.



Figure One: Intraday movement of the Canadian Dollar (CAD) against the US Dollar (USD). The figure above shows a considerable strengthening of the CAD against the USD. CAD strength has been observed after the decision at 15:00 within most major currency pairs. The move against the Euro has been more moderate whilst markets eagerly await tomorrow’s ECB announcement.


The Canadian Dollar operates within a flexible, floating, exchange rate. Therefore, the inflow of ‘hot’ money taking advantage of the higher rate of interest and the differential between major currencies leads to an increase in the demand for CAD. Given that the supply of Dollars will be relatively fixed within the short run, in the absence of immediate monetary responses or forced currency sell-offs, the exchange rate appreciates in favour of the CAD.


Despite relinquishing control over the domestic currency via direct manipulation or pegging, the Bank of Canada does admit that considerable attention is paid to the exchange rate. They do so in order to preserve the international purchasing power of their Dollar and also to ensure that stable rates preserve the exporting competitiveness of the economy. Exports are an important part of the economy particularly given the economy’s exposure to commodities.


In fact, within the document explaining the Bank’s position on the exchange rate, it explicitly states that “the Bank is not indifferent to persistent currency movements”… specifically with regard to the spill-over effects upon “total demand and inflation”. This conclusion follows premises explaining the particular relevance of the external value of the currency, particularly with reference to the US Dollar. Therefore, it is unsurprising that markets and analysts alike did not expect the rate hike that today’s announcement brought. Consider the persistent and considerable appreciation of the Canadian Dollar over recent months:



Figure Two: An 8.1% appreciation of the CAD against the USD since mid-June may have threatened the competitiveness of Canadian exports. Increasing the internationally perceived price of Canadian exports (including the nationally important net-exporter status of commodities) threatens the future growth of the Canadian economy via the net exports channel.


As the explanation of Figure Two argues, the decision to raise interest rates and the concomitant strengthening of the CAD could be seen as short-sighted and harmful. If the decision to raise the target overnight rate was in response to “recent economic data”, as indeed it was, the longevity of optimistic economic data to which it responds could be threatened.


Moreover, the decision acknowledges that inflation is considerably “below the 2 per cent target”. By tightening loose monetary policy, thereby reducing the degree of monetary stimulus, inflation, ceteris paribus, will be subdued. Therefore, today’s rate hike was unanticipated due to the concerns that such a decision will increase the propensity for the strong growth to be undermined and weak inflation to be sustained or worsened.


This analysis may not ultimately manifest; both growth and inflation may pick up. However, Bank of Canada’s admonition over “a moderation of the pace of economic growth in the second half of 2017” suggests that it is an extant concern of theirs too. Ultimately, the effects of an unfavourably strong Canadian dollar may result in a deterioration of the national current account. Over the long-run, the current account deterioration effect could induce a reversal of the Canadian Dollar’s appreciation, unwinding yesterday’s post-announcement gains and the sustained appreciation over the past few months.