The G-20 central bankers and finance ministers are meeting in Chengdu, China this weekend where the theme will be how to revive global growth.
While typically a non-event, this time the subject of exchange rate values may be revisited, especially in the aftermath of Brexit.
The British pound tumbled to a 31-year low and money came back into the U.S. dollar after Brexit but currency rates have since settled down. Long-term interest rates around the globe fell substantially too, but the U.S. stock market welcomed the deferring of any rate hikes here and consequently today, stocks are hovering around all-time highs.
In the midst of all this turmoil there have also been some interesting dynamics going on with the second- and third-largest economies in the world.
China has been quietly driving its currency weaker in recent months to a six-year low, backed by evidence of an unexpected rise in its foreign currency reserves. When major currencies, led by the British pound, were going through extreme volatility, China retreated to the strategy of ‘stability’ and backed away from free-market principles despite international criticism of unfair currency manipulation.
By contrast, Japan suffered greatly, with the Japanese yen recklessly strengthening after the Brexit announcement, hitting a three-year high. By great contrast to the Chinese yuan, the Japanese yen was hit with its highest weekly volatility since the Lehman Brothers bankruptcy crisis of 2008, yet the Bank of Japan stayed clear of any intervention.
Where do we go from here?
My View: First, G-20 will reaffirm that countries should not deliberately weaken currencies and avoid any manipulative devaluation. Despite all this, the Chinese yuan will probably continue to weaken as capital outflow from China persists. The Chinese authorities are most likely to be quite happy to see this as it will help their ailing economy.
Japan meanwhile, observing what is happening to its neighbor, has to come up with additional, aggressive stimuli to help its economy now, and will probably explain this to the G-20 nations.
Many research analysts have already concluded that with the dollar-to-yen trading at 100, Japan will not be able to get out of a deflationary state. Instead of intervening to manipulate the exchange rate, the solution is to clean up and make structural changes. This will be most effective if both monetary and fiscal stimuli are combined – something that other nations have not been particularly good at coordinating yet.
The market has started to sell the Japanese yen in anticipation of this situation and I believe the yen will continue to be under pressure until next week when the announcement is expected to take place.