Currency Wars and A Fist Full of Dollars

We live in challenging and extraordinary times. The beginning of 2015 has seen incredible volatility on the 5.3 trillion US dollar a day foreign exchange market (forex). First to get the ball rolling was the Swiss National Bank (SNB) when it abandoned its three year old currency policy to peg the Swiss franc/euro at 120. The Swiss currency bombshell pounded the euro to a nine year low against the dollar, rattled a basket of emerging currencies and sent investors into the trenches as they rotated out of risky assets and back into safe havens. That propelled gold and silver to new year highs. The modern financial system is a complex interconnected network of entities that when a butterfly flaps its wings in the Amazonian jungle of South America, it creates a hurricane in Central Park. While a handful of pundits may have been able to predict the SNB de-peg to the euro, joining the dots in real time and predicting what impact that would have on other assets across the globe would probably be beyond the scope of human or artificial intelligence. The challenge we face is that we’re unlikely to know all the initial conditions of a complex system in sufficient, or perfect, detail. Due to these infinite variables, it becomes impossible to predict the ultimate fate of a complex system.

Needless to say it would be extremely profitable if a trader could predict the movement of all global asset prices the moment that one event occurs, but it’s probably not realistic.

Nevertheless, by simplifying the matter and focusing on how events might influence a particular currency, stock, precious metal or any other asset class, then a trader has a better chance of predicting its price.

Take for example the Australian dollar. We could predict that the end of the commodity super cycle was likely to have a negative impact on the currencies that have a commodity based economy. I wrote a piece in September 2014, which was posted in December entitled, “Aussie dollar Trouble Down Under,” The Aussie dollar was trading at 88cents to USD “The global economy is slowing down, that is becoming more evident with every bit of data being released and it is likely to accelerate next year”. The sharp decline in world commodity prices, triggered by a slow down in the world economy has reduced the demand for commodities and is depressing prices. Already, this trend is starting to have a detrimental impact on commodity based economies. “Slow global economy and a heavily reliant economy on commodities, means that there may be trouble down under, particularly if the global economy deteriorates further. With a drop in interest rates now likely to be on the cards the sliding Aussie dollar may have just begun making it a shorters delight”. Fast forward five months and that wasn't too difficult to join the dots and call the Aussie dollar trajectory. Today, the Aussie dollar is trading at 0.77 to USD, down a significant 1.3 percent at the time of writing this piece. The sizeable one day fall was due to the Reserve Bank of Australia lowering interest rates, again this move was predictable. When you have lower export earnings due to falling commodity prices, that triggers a fall in Capex and large infrastructure projects. So the central bank responded in the old fashion way by loosening its monetary policy, low interest rates with the aim of propping up business investments and consumer spending.

So what about the Euro? As I predicted in January the euro would experience volatility, it would continue its downward trajectory, which it did do, based on the the European Central Banks decision to launch its own trillion dollar QE programme and uncertainties over the Greek election. I then said that the Euro would reach a bottom following the Greek election and then would start moving upward. This has happened. As far as bad news goes, the Euro has had the kitchen sink thrown at it. With fears over the Greek crisis subsiding and the prospects of good economic data from the euro zone maybe in the pipeline, there might be only one way for the euro now, that is up.

The Swiss franc?

The SNB negative interest rate is saying one thing to foreign investors, your money is unwelcome here. With Russian oligarchs money unwelcome in Switzerland and the US, the euro zone might be one place where they could go next. Note that the SNB isn't done. If they see a further undesirable appreciation in the Swiss franc the SNB could still intervene with more negative rates, or sell the local currency to depress the value of the Swiss Franc.

The US dollar?

That all depends on whether you believe the US recovery is real or an illusion. If it is real, then a rate rise is likely to be on the cards and that would send the US dollar higher.

I don't believe that scenario is likely. In fact there is enough economic data and bellwether earnings to suggest that the US economy isn't doing as well as mainstream depicts. The consensus of a three percent rise in economic activity doesn't seem realistic, bearing in mind that there is no QE to juice assets prices to continue the illusion of a recovery.

I believe that QE is more likely going forward rather than rate rises, bearing in mind that the dollar crisis is hitting US exports. Perhaps US dollar run has done its course and we might see a fall in US dollar moving forward.