Strengthening Currencies Bedevil Central Banks

Upward pressure on Japanese yen, Swiss franc and U.S. dollar complicates efforts by policy makers to spur growth

By Chelsey Dulaney and Corrie Driebusch
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Britain’s vote to leave the European Union has set off a fresh round of currency pressures in the world’s largest economies, further complicating efforts by central banks to spur growth.

The pound hit a three-decade low on Monday, and both Standard & Poor’s and Fitch Ratings cut their ratings on the U.K., saying that last week’s vote raises risks to the country’s economy.

Meanwhile, the Japanese yen, Swiss franc and U.S. dollar posted further gains, as market turmoil resumed after the weekend and sent investors in search of havens. Government bonds also benefited from the flight from risk, with the yield on the 10-year British bond falling below 1% for the first time, as the rout in U.S. and European stocks deepened.

The currency moves, in particular, pose risks for businesses and in turn for economies that have posted lackluster performance.

The resurgent yen and franc are putting renewed pressure on companies in Japan and Switzerland. Meanwhile, U.S. companies that had benefited from a weakening dollar this year face a bout of currency-related stress as the second-quarter earnings season looms.

Stronger currencies tend to make a country’s exporters less competitive as the effective price of their goods goes up. They also tamp down inflation as import prices fall, frustrating outcomes for central banks in Japan, Europe and the U.S. that are trying to calibrate policies to boost growth and inflation.

The moves could tempt central banks to intervene or modify policies to limit the upward pressure.


“Policy makers are unlikely to sit idly by while their strengthening currency derails any economic progress that they’ve made,” said Omer Esiner, chief market analyst at international-payments firm Commonwealth Foreign Exchange. “Central banks would be justified in stepping in.”

The problem is currencies can’t all weaken at once. The Swiss have been trying to push the franc down against the euro. The European Central Bank has nodded to the benefits of a weaker currency as it lowers interest rates into negative territory and expands its bond-buying programs. Japan has tried to weaken the yen against the dollar. And Federal Reserve officials have cited the stronger dollar as an impediment to growth.

All are showing little success, and investors have raised concerns that central-bank tools for influencing currency values are losing their effectiveness.



That situation is most evident in Japan, where the yen has appreciated sharply this year even as the Bank of Japan 8301 5.71 % adopted negative interest rates. The yen had already strengthened by more than 10% against the U.S. dollar in 2016 before the U.K. voted Thursday to leave the EU, known as Brexit. Since late Thursday, the dollar weakened below ¥100 for the first time since late 2013. The yen is up 18% for the year. Late Monday in New York, the dollar bought ¥101.99, from ¥102.20 Friday.

“What the Bank of Japan has to decide is whether they think intervention is helpful,” said Daragh Maher, head of U.S. foreign-exchange strategy at HSBC Holdings HSBC 2.59 % PLC.

“They want to be reasonably confident that intervention will be more helpful than not. They haven’t reached that point.”

The yen’s gains have put pressure on Japanese stocks, as investors worry that the country’s export-dependent companies will become less competitive. The Nikkei Stock Average fell 7.9% Friday after the British result was announced. It rose 2.4% Monday, but is down 20% this year.

Technology exporters such as Canon Inc. CAJ 1.68 % have already warned that the yen’s surge could eat into earnings. Canon, the maker of digital cameras and office printers, said each one-yen appreciation against the dollar reduces its annual operating profit by the equivalent of about $38 million.

The potential threat to already weak Japanese exports is adding pressure on the Bank of Japan to step in to control the yen’s rise. Athanasios Vamvakidis, Bank of America Merrill Lynch’s head of G-10 currency strategy in Europe, expects the central bank to introduce new easing at its next policy meeting, which is scheduled for late July.

“Given the substantial risks that the Bank of Japan will not be able to meet its inflation target, you want a currency that’s somewhat undervalued,” said Mr. Vamvakidis. “Further strength in the yen would be a big problem.”

The Swiss National Bank SNBN 1.10 % is having similar trouble controlling the rise in the franc. It said Friday that it had intervened in currency markets, the most overt early reaction by the world’s monetary authorities to the British vote. The franc weakened against both the euro and dollar over the past two sessions but remains up for the year.

“In terms of redirecting the market from migrating to the Swiss franc, I think it will have a marginal effect at best,” said Peter Rosenstreich, chief market strategist at Swissquote Bank.

Meanwhile, the dollar’s strength is posing a renewed threat to U.S. companies’ profits as the second quarter draws to a close. The WSJ Dollar Index, which measures the greenback against 16 other currencies, had fallen 5.6% this year before the U.K. decision. Over the past two days, the dollar index has rebounded 2.7%.

Analysts had expected U.S. corporations in the S&P 500 to post slight earnings growth in 2016 after a 6.6% contraction in the first quarter and an expected decline in the second quarter, which ends this week, according to FactSet. But the dollar’s surge in the wake of the referendum is causing investors to re-evaluate those assumptions.

“If we were expecting earnings growth slightly positive for the year, Brexit is enough to move the dial down to flat or negative for earnings growth,” said Nathan Thooft, head of asset allocation at John Hancock Asset Management.

The market turmoil and strength of the dollar are expected to keep the Federal Reserve’s interest-raising efforts on hold. The Fed doesn’t target currency levels, but officials have repeatedly cited the dollar’s strength as a drag on growth. Markets expect little chance of a rate increase this year and in fact are pricing in small odds of a rate cut. Higher rates would make the dollar more attractive to investors.

One group of potential beneficiaries of the recent moves in currency markets are British exporters.

With sterling slumping—trading at $1.3225 late in New York on Monday—British goods will become significantly cheaper to overseas consumers. That has helped support the shares of big U.K. companies despite the market tumult. The U.K.’s FTSE 100 Index, which includes many British exporters, has fallen 5.6% over the past two sessions, compared with the 11% decline for the broader Stoxx Europe 600 index.

Yet shares of U.K. real-estate companies, banks and airlines have been battered, as investors worry that a Brexit would dent investment and spending in the U.K.

“A weaker currency should by and large help British exporters. It should help raise inflation, which has consistently run below the Bank of England’s target,” said Mr. Esiner of Commonwealth Foreign Exchange. “But it does cause investors to pause and rethink investments in the U.K.”

Many analysts said the potential slowdown in the U.K. economy could prompt the Bank of England to ramp up stimulus in the coming months.


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