The fear of a return to a 2008 environment seems still to be a topic on people’s minds. I am sometimes accused of being overly negative in my outlooks. However, it is part of my job to identify risks. I have always been a believer in managing downside risk well, as the upside usually takes care of itself.
Having said that, I just don’t see a repeat of 2008 on the horizon. However, if the world’s financial markets decide to take another tumble, there are a number of incidents most likely to kick it off. One of these is a war of the currencies.
The Swiss Franc was a wonderful currency. Stable and predictable, at least until a couple of weeks ago, when the Swiss woke up to a currency that was suddenly 30% more expensive. Even if some of those ‘gains’ were given up later in the day, CHF/EUR still ended up about 15% on the day. A simple decision by the Swiss National Bank to untie CHF from EUR, which was fast becoming a prohibitively expensive policy, was behind the big move.
With CHF ‘out of the way’, currency speculators have turned their attention to which currency to attack next, and the favourite seems to be DKK. The Danes have kept DKK within a very narrow range against EUR for a number of years, and have had to lower short-term rates in Denmark three times since the CHF incident to keep the Danish currency sufficiently unattractive to speculators.
It is not unreasonable to expect DKK to strengthen meaningfully, should the tie be loosened. The Danish media has been full of reports on how unlikely it is for the Danes to drop the link, as there is absolutely no political desire to do so and, while that is probably true, the real world works a little differently, as the Swiss found out.
In other words, a more ‘coordinated’ attack on DKK at some stage is quite likely. Whether the Danes will throw in the towel like the Swiss did remains to be seen, but it is nevertheless too small a currency to have the sort of impact a stronger CHF will have going forward. (I am Danish and like to think of Denmark as the centre of the Universe but, in reality, it is not).
Whatever is going to happen, there is a much bigger story here. The eurozone at first, and then the policies pursued to address the credit crisis (mainly QE), have largely eliminated interest rates as the key policy tool for monetary authorities. In their place, exchange rates have taken over – not as dictated by the powers that be but by financial markets, at least so far.
Going into a period of relatively low economic growth, and with further interest rate cuts likely to be largely futile, it doesn’t take a lot of imagination to picture the currency market becoming a playground for political leaders around the World (more than it already is). I don’t know yet who will play this game the best, but expect plenty of exchange rate moves in the months and years to come.
Niels Jensen is CIO, Absolute Return Partners
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