Currency markets are not all about the euro

The eurozone crisis has focused the attention of analysts and investors on the single currency, but there are also other trends taking shape in currency markets.

The euro, the dollar and the pound. Over the past few months, these currencies have been the subject of fierce debate among foreign exchange analysts. The survival of the single currency was the hottest topic, closely followed by the implication of further quantitative easing in Western economies.

Lesser-known currencies have been affected, and the fallout is likely to shape investors’ strategies when it comes to FX investments. The current liberal monetary policy of heavily indebted developed countries (HIDCs) gives an idea of what could happen when currency realignment becomes the main tool to erase global imbalances.

Jan Dehn, head of strategy at Ashmore Investment Management, says a liquidity crisis is threatening treasuries. Over the past few years, emerging economies have accumulated huge foreign reserves, contributing to the global imbalances by investing in government securities from the biggest borrowers.

Currency wars

Given the recent stasis in currency markets, currency realignment has become the main protection against global imbalances created by the excessive debts in developed countries against excessive foreign exchange reserves in emerging markets. When economic fundamentals such as interest rates, growth rates and inflation begin to move, Dehn warns, a real currency war kicks off.

The expression ‘currency wars’ was coined by Brazilian finance minister Guido Mantega to describe the damage inflicted on emerging markets by over-easy monetary policies in developed countries, just a month after the Federal Reserve launched its second round of quantitative easing (QE2) in 2010.

Dehn recalls: “Quantitative easing, [Mantega] argued, weakens HIDC currencies, undermines emerging market exports, saps their growth and in the final analysis transfers the cost of adjustment from ­developed ­countries to emerging markets through currency weakness.”

According to the strategist, Mantega’s currency war has not gone away; it is merely on hold, in much the same way that phoney wars presage the outbreak of real hostilities.

“Temporary economic conditions and policy choices keep currencies locked in relatively stable ranges, but these conditions are not immutable.

“Deleveraging will unfreeze credit markets, resulting in higher spending, stronger growth, and eventually rising inflation risks.

“The US Federal Reserve will be forced to raise rates and to reverse its unorthodox easing measures,” Dehn adds.

Ashmore Investment Management hopes that the process of unwinding the global imbalances will happen slowly, as the alternative could be a mighty dollar crash.

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