Unconventional Wisdom -Reflationary currency markets :: Macquarie Research,

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Unconventional Wisdom
Reflationary currency markets
Event
 The US$ is sliding to new lows against a range of currencies.
Impact
 The ongoing weakness of the US$ is a positive development for the global
economy.
 One reason is the boost to foreign exchange reserves which has to be
deployed in asset markets. But just as important is the brake that will be
applied to monetary tightening outside the US.
 The US is effectively exporting its ultra-low interest rates to the rest of the
world and this will be one of the factors underpinning global growth.
Analysis
 Contrary to widespread expectations, the US$ has not strengthened so far in
2011. In fact the US$ is now hitting its lowest point of the year against a range
of currencies.
 For major currencies the US$ has set a new low against the Swiss Franc.
Against the Yen, the US$ was only briefly lower just after the March
earthquake. It is also telling that the Euro has fallen by less than 5% from this
year’s peak against the US$ despite the huge upheaval in Euro bond markets.
 US$ weakness against the currencies of emerging economies is even more
apparent. New 2011 lows have been set against the currencies of important
countries such as China, Korea and Brazil.
 As a result, the US TWI has fallen by about 5% since the start of the year.
The drop since the peak in early 2009 has been about 20%. While this is a
positive sign for US growth because of the improvement in competitiveness,
this is by no means the only plus from the weaker US$.
 One of the immediate impacts of a weak US$ is stronger growth in global
liquidity. The reason is that a number of countries resist the appreciation of
their own currencies against the US$ and intervene in currency markets. US$
purchases are then invested, often in US fixed interest markets, which helps
to suppress yields in both the US and around the world.
 This expansion of official balance sheets outside the US is one of the most
important sources of global liquidity growth. History shows that the growth rate
of foreign exchange reserves tends to be strongest when the US$ is weakest
and vice versa. The current low level of the US$ is yet again associated with
firm growth in global foreign exchange reserves.