Major Overnight Headlines
• UK government to delay parliamentary vote on Syrian intervention until UN inspectors report concluded
• German unemployment up for first time since May in July (+7k); August French Business Confidence rises
• Bank Indonesia signs $12bln bilateral swap deal with BoJ as key interest rate lifted 50bps
The USD firmed up nicely this morning in London. Month-end flows aside, it’s quite likely that the move higher in the currency also reflected a return to “macro and data-dependency mode” as we await the result of the UN chemical weapon inspection teams in Syria. Prudent as ever, Britain’s incremental approach towards the Syrian situation has shifted the focus of market participants back on the economic data; the first stop being US jobless claims and revised Q2 GDP due this afternoon. The tapering debate is back.
Developing economies sit faced with a further, persistent drain on their FX reserves, and those reserves are not growing nearly as fast as they once did. But the risk here is that amidst the hysteria and the hype, all of us take our focus off the underlying, structural issue: the failure to control volatile capital flows on a global basis. It’s very easy to see why we can get caught up in the short-term “fighting of fires”. Sharp declines in developing market currencies are pernicious, and there is no shortage of tools which can be deployed as patch jobs when they occur: rhetoric, monetary tightening, swap lines, reserve sales, reserve pooling, IMF credit lines and so on and so forth. But the availability of “smoothing tools” simply begs the question: was the unprecedented scale and speed of developing market reserve accumulation pre-crisis really all that desirable, and has the scale of central bank liquidity injected since simply added to the problems? On various measures including GDP (Chart 2) and external debt, FX reserves are if anything probably too large, not too small. But a stockpile of FX reserves, no matter how large, cannot halt a vicious cycle of declining confidence. That means the root cause of the problems needs to be attacked when the timing is right.
As the Fed makes adjustments to the size and delta of its balance sheet, it might not be a bad idea for it to adopt a “Bretton Woods III” – style approach. At the same time, developing market policy makers need to be ahead of the change in the flows in both directions. Until then, the Fed still holds the key. All eyes on the Fed.
Read the full report: FX Daily
BMO