Will The World Intervene To Stop The Dollar Slide?

Currency volatility continues and credit market losses widen as J. P. Morgan Chase & Co. and the New York Federal Reserve had to bail out Bear Stearns, one of America's largest investment banks.  DK Matai, Chairman, Asymmetric Threats Contingency Alliance (ATCA), sees this as “the clearest ‘red alert’ signal yet, that the country's financial system is in the middle of a violent spasm with the potential to spark the worst meltdown since the Great Depression.”

The dollar sank below 99 yen, to the weakest in 12 years, and slumped to a record low versus the euro and also plunged to below one Swiss franc for the first time. The dollar set record lows as investor confidence tumbled, sending U.S. stocks lower for a third straight week and driving gold to a record high of $1,009 an ounce.

With the Yen hitting all time highs against the dollar, hurting an economy that earns dollars on exports, speculation is increasing that world government intervention may be the next step in controlling the market volatility and propping up the failing dollar. The dollar fell below 100 yen for the first time since 1995 as fears grow that the US economy is slipping into a recession.

Japan’s long recovery from recession in the 1990s is fuelled largely by exports and a US recession is expected to hit Japan particularly hard. Consumer spending is still sluggish, the population and growth in wages is slow.  Last weeks’ rise in the yen alarmed exporters whose products benefit from a weak yen. We’re pushing ahead with expanding our global businesses, but there is fear that earnings at overseas subsidiaries will deteriorate because of fluctuating exchange rates,’ Kazuyasu Kato, president of brewer Kirin Holdings Co. Inc., told the local press.  A recent poll showed that almost two-thirds of Japanese corporate executives are worried that the yen’s recent surge against the dollar will hurt earnings. The survey also showed that corporate heads were increasingly worried that the US slowdown would spread to emerging markets. The survey was conducted by the Nikkei business daily and it showed that sixty-four per cent of company presidents surveyed in sectors ranging from finance to manufacturing to retail said the stronger yen along with financial market trouble would hit their exports. A weak dollar would also decrease the value of repatriated dollar earnings.

Little or no current intervention from governments

So far, most countries have been more or less happy to watch the dollar slide as intervention is no panacea, and the longer the trend, the more bouts of intervention usually are necessary to turn the currency in question. In the euro zone, export growth has performed well even as the euro strengthened and a rising currency has helped keep a lid on inflation. The Japanese government has so far taken no action to stem the sliding dollar, reluctant to restart its dollar-buying and yen-selling intervention that it halted in March 2004 and although Japan's top economic officials voiced renewed concerns on Friday about the U.S. dollar's rapid decline against the yen, they provided few hints about whether Japan would intervene to help the U.S. currency.  The yen's jump against the dollar is relatively recent and, versus a basket of currencies, Japan's exporters have been less vulnerable than previously when more countries were pegged to the dollar.

Policymakers may well remain on the sidelines even if exchange rates get further out of control. One of the G7's most pressing goals is persuading China to let its currency move to the whims of the market - any co-ordinated intervention would be seen as hypocritical.

Another problem is that intervention is more effective when global monetary policy is aligned. So far, just the US economy has hit a wall. If the rest of the world follows, the probability of intervention will rise, but it is by no means certain. There has been US reluctance to interfere with market-driven price adjustments and European finance officials are hesitant to take action unilaterally. Juncker, the Eurozone group of finance ministers head, indicated that intervention was not even discussed at the recent meeting.

Is it now time for intervention?

Intervention works best when it is supported by monetary policy and economic fundamentals.  It’s easier to prop up a weak currency if interest rates are moving higher and growth is positive. In the current USD situation, those two conditions are clearly not met and don’t seem likely to be met for several months ahead, contributing to the reluctance of the US Treasury to support action.

Policymakers from the world's most developed nations seem to share the view that currencies should trade freely. But given the sharp moves in exchange rates this week, particularly the fall of the dollar, there is growing talk of intervention in which central banks buy and sell currencies to influence exchange rates.

Goldman Sachs Group Inc. and Morgan Stanley said coordinated action by policy makers to stem the currency's slide is increasingly likely. "The market is certainly on intervention watch," said Hans-Guenter Redeker, global head of currency strategy in London at BNP Paribas SA, France's largest bank. "If I was in their shoes I would intervene in a concerted way that supported the dollar." “Such is the pressure being brought to bear upon the greenback right now that we strongly suspect that the subject of central bank intervention will remain the predominant theme,” said Neil Mellor at the Bank of New York. In spite of its supposed "strong dollar policy", the US economy needs all the help it can get.

Fears are growing that the rational rebalancing of global currencies has degenerated into a full-scale dollar crisis. On many measures the dollar is already cheap, but a plunge in confidence in the currency, and in dollar-denominated assets, risks a vicious circle of selling. If policymakers collectively feel that currency markets have lost the plot, they may well step in. Japan is badly troubled by the weakness of USD/JPY, but the JPY remains relatively cheap compared to other currencies, so the case for unilateral Japanese intervention is limited, but would support a joint effort. Past co-ordinated efforts - for example reversing an overstretched yen in 1995 - were surprisingly successful.

European Central Bank President Jean-Claude Trichet echoed the G7’s words when they met in February by saying on March 13 that ``disorderly'' moves among currencies were ``undesirable.'' The latest round of turmoil prompted EU leaders on Friday to call on the banks to help stabilise nerve-wracked financial markets as they also sounded the alarm about the euro’s record-breaking gains. “We would like to invite financial institutions to help reduce the instability on financial markets within their limits,” Slovenian Prime Minister Janez Jansa told reporters after chairing a summit of EU leaders. EU leaders said that sharp swings in exchange rates “are undesirable for economic growth” and that “in the present circumstances we are concerned about the excessive exchange rate move.”

Not waiting for world unity, the Bank of Israel Governor Stanley Fisher took the entire country by surprise last Thursday and Friday when he engineered intervention to slow down the shekel's overvaluation. It was the first time in 11 years that the bank had bought dollars to impact currency dealings.

Markets will be on high alert over protests against yen strength by Japanese officials. "Excessive volatility in the foreign exchange is not desirable for global economic growth," Finance Minister Fukushiro Nukaga said on Friday. "From now on, I'd like to monitor foreign-exchange movement with great interest." Indicating that the finance ministry has raised its alert level slightly. Economy Minister Hiroko Ota, echoed Mr. Nukaga's warnings against a volatile dollar-yen exchange rate. But Mr. Nukaga, who oversees Japan's currency policy, didn't go as far as to threaten intervention. Naoyuki Shinohara, vice finance minister for international affairs, also declined to comment Friday about the chances of intervention.  At this stage, the comments have not been strong enough to suggest that the authorities are considering intervention, but there will still be major caution over yen buying below the 100 level against the dollar.

Strategists at UBS AG, the world's second-biggest currency trader, wrote in a March 3 report that the G-7 may signal its intent to consider coordinated intervention. The group is made up of the U.S., Japan, Germany, the U.K., France, Italy and Canada.

What this means for traders

Dealers noted that in late trade the dollar steadied slightly amid speculation that central banks might be considering intervention — although most thought this unlikely. “Rumours from market players that central banks had been checking rates ... prompted a dollar pull back,” said Richard Pace at Thomson IFR Markets. The dollar briefly rebounded yesterday on speculation that global central banks may give support to the ailing currency for the first time since 1995, when it sank to a post-World War II low of 79.75 yen.

Mike Paulenhof, has a theory  having spent eight years proprietary trading foreign exchange for a major NYC bank: “that the powers that be realize the dollar has to stabilize or be stabilized and that the carte blanche one-way "freebie" dollar short has got to come to an end -- to ensure that the global financial markets do not implode. If the G-7 or the G-10 coordinated a powerful intervention to sell euro and yen, to buy dollars, then my sense is that a massive one-way trade would rip towards the exits, the dollar could soar 5%-8%, gold and commodities would take a bath, oil would plunge, the flight-to-quality in bonds would be reversed, and money likely would flow into equities in a hurry.”

While Brian Dolan of Forex.com advises that he “would not count on intervention materializing anytime soon. Intervention does become more likely if the death spiral scenario materializes, meaning 2-4% declines on successive trading days. In that event, however, long-USD positions are likely to be forced out before intervention would ever materialize. Traders are likely better advised to keep selling USD-rallies and taking profit as new lows are made. Bear in mind that many USD-pairs are in uncharted territory, keeping fresh USD selling somewhat ambivalent, which the specter of intervention also increases. As such, short-term volatility is likely to remain high, which should give patient traders opportunities to sell USD at better levels. Liquidity conditions will thin out as we head into the Easter Holiday at the end of next week, and that will likely also increase short-term volatility. As well, pay close attention to any shift in rhetoric from G3 (US, Eurozone, and Japan) finance officials suggesting intervention is being discussed.”