Every so often, I’ll check in to show items floating around Wall Street circles and blogs.
Longer term trends in the markets and economy.
Extra details on what seems underappreciated or overhyped.
Link to some great explainers on the concepts.
**Everything as of 9/17/2023
FX Market Drivers
OTC FX markets are the biggest and most liquid markets in the world. In any top down review of the economy, the demand or lack of demand for a currency can say a lot about deep trends in that economy. If all markets are an ocean, then FX would be the Gulf Stream deep beneath the waves of bond trading and the choppy wake of equity markets.
USD Summer Strength
The past two months have seen a sharp strengthening for the USD, counter to the general weakening we’d been seeing in USD since September 2022
Whenever the demand for U.S. dollars moves aggressively higher or lower, the usual suspects come out to start warning of chaos and Mad Max style results. When we have a strengthening dollar
U.S. consumers - benefit from cheaper imports and less expensive foreign travel because they can buy more with a dollar
U.S. companies - lose out via fewer exports sales and are financially hurt when the dollar strengthens.
Shout out to the best hedgers of their FX risk by doing both the importing and the exporting.
So business are going to complain and argue it’s bad. Putting aside the obvious bias of only businesses complaining, the question still remains why is the USD strengthening recently?
America needs a reason to strengthen?
The most parroted answer is that U.S. interest rate hikes make the USD stronger. That was true in the big run up 2 years ago (see chart above) but I don’t think it’s the driver for this summer specifically. Two other things have caught my eye.
Japan
A tidal change may be in the works for the USD/JPY exchange rate. Taking a very zoomed out view of prices going back to 1971, we can see the USD was weakening for decades before bottoming and now, since 2020, there’s been a change.
The big speculation this summer is a countdown to the end of Japan's NIRP (Negative Interest Rate Policy) by their Central Bank, The Bank of Japan. Zooming in we can see a real run of strength in USD against JPY this summer, suggesting a strengthening USD may be just getting started versus JPY if NIRP does finally end.
Emerging Market currencies
The Mexican Peso plunged 2 week ago after the Bank of Mexico announced it intends to gradually reduce it’s FX-hedging program. Basically, Bank of Mexico had been buying/selling pesos (mostly buying) to keep the volatility at bay and keep their currency strong. Now they’ve announced they will slow this policy. The change will weaken the peso and strengthen the USD and sure enough….
Fun Fact: Technical Analysts would say Buy The Dip!
The Mexican peso's plummet prompted the Argentine central bank to hike rates (to 118%!) and devalue the official Argentine peso rate to 350/USD in an effort to reassure markets and to prevent a broader selloff of Argentine assets from spreading. This action too has the effect of strengthening the USD but this time against the Argentine currency.
It hasn't worked yet
Bottom Line - FX Traders needs to pay attention to the other “denominator” currencies just as much as the USD Fed Policy when judging direction of the USD. Much more strengthening may be coming if these foreign monetary polices continue.
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