THE US Federal Reserve announced yesterday evening that it would be making no changes to its $600bn Treasury bond purchase program and would not be making any alterations to its interest rate. The Fed made no reference to the crisis in Japan, however its predictable continuation of its current interest rates will maintain the pain being inflicted on Japan by the crucial yen-dollar pairing.
The forex news is constantly dominated by announcements made by central banks, in times of relative calm as well as, in the case of Japan or the European Central Bank (ECB) this week, times of crisis.
Yesterday, in an attempt to keep the yen from surging against the dollar, and to keep interest rates low, Japan’s central bank, the Bank of Japan (BoJ), offered to make ¥20 trillion available in order to make sure that banks had sufficient liquidity to deal with the huge spike in demand for funds inevitably following the tragedy.
The BoJ said it will also buy about ¥2 trillion of Japanese government bonds via a reverse repurchase agreement. At the same time it also offered to provide ¥5 trillion each of one-week and one-month loans against pooled collateral.
Societe Generale predicts that the economic damage to Japan from the disaster will be between ¥10 and 20 trillion ($125-250bn). Though the figures may seem extreme, as a net exporter, the BoJ will see itself as having no choice but to carry out these injections of liquidity into a country which relies on a low yen against the currencies of major importing economies.
Under the current monetary system, employed for better or for worse in the majority of economies, the central bank has as its main tasks the manipulation of currency prices and interest rates. As such, central banks are the most influential actors in the forex market. An increase in interest rates will encourage traders to invest in that market as demand rises, the currency becomes scarcer and consequently more valuable. Investors are drawn to the currency, causing it to appreciate, because they will gain a higher yield on their investments. In order to purchase the country’s assets (stocks or bonds), investors will have to convert their domestic currency to the target country’s currency, which in turn will also increase demand. Conversely, a fall in interest rates dissuades investors from purchasing assets in that economy, as the return on their investment is now smaller. The economy’s currency will depreciate as a result of this weaker demand.
Whereas the scale of the events in Japan make an easy case for the behaviour of the central banks and their injection of huge funds into the economy, the policies of the US Federal Reserve and the ECB are not such a black and white picture.
A key date in the diary for forex traders ought to be the meeting of the governing council of the ECB on 7 April when an interest rate announcement is set to be made. Analysts predict that the fund will increase its interest rates, which some will see as a big mistake. Michael Hewson, market analyst at CMC Markets, says: “Raising the interest rate will really hit the struggling peripheral eurozone countries hard, reducing liquidity and really making them feel the pinch. It is astonishing that the ECB is considering a raise when the likes of Portugal, Ireland and Greece are recording a negative GDP. It will further widen the gap between the likes of Spain, who will likely be tapping the bailout fund for money, and those with more solid economies, such as Germany, who will be expected to underwrite them.”
The role of central banks will always be a divisive issue, but unless America’s Ron Paul is elected in a shock landslide in 2012, they are here to stay. As such, given their huge influence, anybody watching the forex markets should have the schedule of the central bank meetings of all the major economies printed out and taped to their fridge, their bathroom mirror and their desk.