Quantitative easing (QE) became the preferred non-standard policy tool among central bankers starting in 2007 as more and more large central banks reached the zero interest rate policy bound and were forced to become more creative. Regardless of where you stand on the issue, it goes without saying that without the implementation of QE, the global economy would still be in tatters.
Over the past several years, the Fed hasn’t been alone in its efforts to weaken its currency to help domestic exporters. For example, the Bank of England has expanded its monetary base by five times since 2008; the Swiss National Bank implemented a currency floor for the Swiss Franc against the Euro to stabilize trade.
In 2013, the most notable offender has been the Bank of Japan, who in an effort to pull the country out of a two decade long deflationary spiral (Japan has been (in)famously mired in a more-than-two decades long deflation spiral) has pulled the rug from under the Yen quite literally. From January 1, 2008 to November 14, 2012, the Yen had rallied by +43.21% against the British Pound; +38.14% against the Euro; and +28.97% against the US Dollar. Since mid-November, when it became clear that Shinzo Abe would rise to power as prime minister, the Yen has been ‘competitively devalued’: it lost -20.42% to the British Pound; -26.69% to the Euro; and -23.52% against the U.S. Dollar.
Clearly there is a distortive effect by ultra-easing policies on FX markets. The effects are not limited, however, as investors’ risk tolerance is completely altered. Consider the performance of the U.S. equity market the S&P 500 (yellow) compared to the size of the Federal Reserve’s balance sheet ($M) (white). The rally in U.S. equities – the benchmark for high-grade risky assets – can be wholly attributed to the rising Fed’s balance sheet, as the chart above implies.
Now that the BoJ has engaged in QE, the Nikkei 225 stock index is soaring, up +32% in 2013 thus far. With the BoJ’s QE plans in place for at least the next two years, investors will continue to jettison Yen-denominated assets in search of yield. But this brings us back to the earlier point about trade: the weaker Yen means that major trading partners, such as the United States, the Euro-zone, and Australia and New Zealand, will have to enact counter measures to prevent their domestic exporters from bearing the pain.
On several occasions early in the year RBNZ Governor Wheeler commented that the elevated New Zealand Dollar exchange rate was hurting the nation’s manufacturers, while noting his desire to “smooth the peaks” in the high yielding currency. These efforts have been minor thus far, and yet the New Zealand Dollar is barely dislodged. There’s little reason to think the RBNZ is going to be able to turn the tides anytime soon.
If there is one thing we can expect with a fair degree of certitude, it’s that competitive devaluations are here to stay for the next several years. The Fed is doing it, the BoJ is doing it, and as time passes, more and more central banks will be forced to engage in ultra-easy monetary policy.