Weak currencies go out of fashion
Faced with disinflationary forces over the past 20 years and especially during the pandemic of last year, most developed countries preferred weak currencies to support export growth. Competitive devaluations, increased interest in the US Treasury report on currency manipulation, and the term “currency wars” were all synonymous with assumptions that inflation was dead and that all economic levers, including the currencies, should be used for growth.
There are signs that monetary preferences are starting to change. The renminbi leads the pack among major currencies this year. The broader, trade-weighted renminbi is up nearly 6%. The move appears to be at odds with fears of a Chinese slowdown, the reduction in reserve requirements of the People’s Bank of China and concerns about Evergrande in the Chinese financial sector.
How to explain it? We suspect this decision is related to some of the issues we discussed in an article in May. Rising commodity prices have been a concern of Chinese policymakers for some time, and this concern has been supported by China’s unprecedented sales of strategic reserves from energy stocks and industrial metals. More recently, Chinese policymakers have called on major energy companies to secure energy supplies for this winter at all costs. A stronger renminbi certainly helps in this exercise.
Soaring energy prices are also starting to challenge exchange rate policy preferences elsewhere in the world. Central banks where tightening cycles are underway, especially in emerging markets, would favor more stable or stronger currencies. And in the developed space, Norway and New Zealand have already started to tighten their cycles and would not be against the currency’s strength. Quite on the other end of the spectrum are the central banks of the eurozone, Sweden, Switzerland and Japan, all of which retain all their fears of disinflation and show no signs of shifting to a less accommodative stance.
This brings us to the dollar. Here, Fed policy expectations are shifting and we are now advancing our dollar rally forecast.