Someone should tell the ECB that in a currency war, you’ve got to bring it to get it.

February 5, 2021

12:44 pm

Someone should tell the ECB that in a currency war, you’ve got to bring it to get it.
  • Early 2021, and lockdown is dragging on. Not quite the siege of Leningrad (that was 900 days long), but it’s starting to feel a bit like it. Speaking at a remote Davos event, Barclays CEO Jes Staley said that while WFH had been successful, his company’s esprit de corps was starting to fray at the edges, adding that, “It will increasingly be a challenge to maintain the culture and collaboration that these large financial institutions seek to have and should have.” (‘Barclays boss Jes Staley: working from home ‘not sustainable’’, City AM, 27/01/2021).
  • Central Bank press conferences are a victim of this phenomenon too. A decline in deference was evident in the slightly ratty tone to the questions fielded by Jay Powell in the Fed’s January meeting, especially as journalists pushed him on the topic of what appears to be the start of a chat-room led equity short-squeeze insurgency in stocks like Gamestop (GME.US). Jay Powell managed to get through the event largely unscathed, even so far as putting up a heroic defence of Fed policy (quantitative easing in particular) by saying it had not contributed to asset price inflation.
  • Fed zoom press conferences are at least given a frisson of excitement as the audience gets a ‘rate my Skype room’ moment when the journalists ask their questions. No such levity for the ECB. President Christine Lagarde now seems to revel in the scripted nature of the press-conference encounter. On the 20th January, she read and re-read the same scripted lines (on the possible non-utilisation of the full capacity of the Pandemic Emergency Purchase Programme) at least three times. That such a dour topic occupied so much of the event (this is after her opening remarks dragged on for at least 15 minutes) tells you all you need to know about how exciting it was.
  • Lagarde was ultimately the bearer of bad news. Despite an expected rise in inflation in Q1 (due to German VAT-exemptions expiring), inflation was likely to remain low or negative. Her monotone delivery notwithstanding, the message was that the resumption of lockdown would mean a double-dip recession in Europe was likely. Even a question about central bank digital currency was batted away with a claim it would be at least five years away. Five years’ time, five-year plans. All quite depressing, an air of decline and failure. All a bit – Soviet.
  • Lagarde was also asked about the strength of the euro, and her reply was that the ECB was monitoring exchange rates very closely due to their effect on inflation. The graph below shows the problem. EU-area CPI inflation (blue) has been falling for some time, but the spike in the euro against the dollar (yellow) following the pandemic has not only accelerated the process but highlighted the difficulty which the currency area has in generating inflation in the face of an appreciating currency even with low rates, QE and fiscal stimulus.

Source: Bloomberg, 28th January 2021. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.

  • The Eurozone runs a current-account surplus, exporting more than it imports. All else equal, a balance of payments surplus means one’s currency appreciates. On paper at least, this also reflects a lack of demand in the domestic economy. Because of how the Eurozone works, it also reflects an export advantage to Germany as the euro is weaker than the deutschmark would have been (thanks to Italy and the rest of the club Med countries). These imbalances are internal to the Eurozone too, but without the usual currency movements to offset them in the medium to long term. This has stifled consumption and is why real GDP growth in countries like Italy has stagnated under during the lifetime of the euro.
  • In addition, in 2020, the Fed cut rates more and did more QE than the ECB, while the US government has comprehensively outspent the EU (and everyone else for that matter). While President Biden ponders America’s next $1.9tn Covid-19 relief package, France’s finance minister Bruno Le Maire has publicly condemned the slow, bureaucratic and limited nature of Europe’s own €750bn recovery fund (‘France pushed EU to quicken recovery fund payments’, Financial Times, 28/01/2021). It is worth noting that a year on from the start of the pandemic, no money has been distributed – July 2020’s historic European Commission joint-bond declaration now seems less Hamiltonian and more Rip Van Winkle.
  • If one is talking about European malaise, one has unfortunately always to mention Italy. Prime Minister Conte has resigned and is looking to form a new government. The administration’s ability to organise a proper plan for its share of the EU recovery fund is being called into question due to the political instability, and there are wider questions about Italy’s wider allocation of resources to real growth projects (‘Italy crisis raises concerns about EU recovery spending, Financial Times, 28/01/2021). The Italian government bond market is a little choppy but is not misbehaving too much. The reality of the extent of Italy’s economic problems is nonetheless starting to reflect in political instability, and this is clearly a warning sign of sorts.
  • The biggie though is the vaccine. The European Commission (EC) took the lead in the procurement process, and in a moment of solidarity during the crisis, all EU countries acceded to this common approach. It seems that, possibly under influence from the Elysee Palace, the EC focussed on the Sanofi SA vaccine whose trials foundered during the summer of 2020. When the US and UK were aggressively ordering both Pfizer and Astra-Zeneca vaccines in July, the EC demurred until November due to concerns over cost and the like. The ongoing and unsightly spat between the EC and Astra-Zeneca belies a catastrophic mishandling of the situation which has resulted in a push for ‘vaccine nationalism’ and vaccine export curbs by Germany and Belgium amongst others. The ill-will and discord this causes is one thing. The delay to the reopening of the European economy is another. Unnecessarily higher mortality levels due to bureaucratic miscalculation will be the ultimate measure. How very Soviet.
  • With this unsettled backdrop and during a day when the equity market was showing increasing signs of disquiet (the VIX volatility index rose to a high of 37.2 on the 27th January), the ECB decided it was time to wade into a currency war. Clearly President Lagarde’s commentary on watching exchange rates in the prior week’s ECB press conference were insufficient. Headlines hit suggesting that ECB officials felt the market was underestimating the odds of another ECB rate cut. The deposit rate is already at -0.5% and given the dual-rate set up (banks already get a more favourable rate if they lend so the official deposit rate is not as critical to the monetary policy transmission mechanism), any further cuts could only be an overt attempt to weaken the currency. The moment when the headline hit can clearly be seen in the EUR/USD graph below:

Source: Bloomberg, 28th January 2021. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.

  • As if to ram home the point, the 28th January saw ECB board member Olli Rehn say on Bloomberg TV, “We are certainly ready to use and adjust all our instruments as appropriate…We are closely monitoring developments in the exchange rate, especially regarding the inflation outlook” describing the region’s inflation outlook as “too low for my taste, and more importantly, too low for our aim.”
  • The ECB’s problem here is that there is difference between saying something and doing something, and even when they say things, they rarely do so in unison. A day after Rehn’s Bloomberg interview, Gabriel Makhlouf, head of the Bank of Ireland, went on the tape saying,


  • Predictably, the Euro has rallied against the dollar following this rowing-back of intent. The graph below again highlights the ‘underestimating rate cut’ headline (circled in red) and where we are a few days later, over 30bps higher at the time of writing. This is not how you fight a currency war.

Source: Bloomberg, 28 January 2021. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.

  • The problem for the ECB is that a currency war is a competition, and a zero-sum game at that. The new Treasury Secretary Janet Yellen has pledged to “put effective pressure on countries that are intervening in the foreign exchange market to gain a trade advantage.” The US named Switzerland a currency manipulator in December 2020. In an interview with the Senate Finance Committee as part of her selection as Secretary of State, Yellen said,
“The president opposes attempts by foreign countries to artificially manipulate currency values to gain unfair advantage over American workers…. The Biden-Harris administration will be examining how Treasury, Commerce and USTR can work together to put effective pressure on countries that are intervening in the foreign exchange market to gain a trade advantage,”

(‘Yellen Faces ‘Currency War’ Redux as She Ditches a Strong Dollar’, Bloomberg, 28/01/2021)

  • If one were to place bets, there is only one winner in a footrace between the ECB and the Fed. The ECB’s problem is that it is institutionally weaker as an organisation as it is a supra-national central bank, unlike the US Federal Reserve. The Fed also oversees the world’s de facto reserve currency, and everything it does just matters more.
  • There are however still lingering doubts in some quarters about the durability of the euro as a currency, although this is something vigorously disavowed by the ECB, the European Commission and by most politicians. Anti-euro rhetoric is still not that popular – right-wing parties in Italy have flirted with it in the past, as did the fascist Marine Le Pen in France, although it is interesting that she has since dropped her policy of wanting to take France out of the euro. What is clear though is that if the foreign-exchange markets are to become battlegrounds, then one ought to expect much higher volatility across all asset classes. Goldilocks this ain’t.
Unless otherwise stated, all opinions within this document are those of the RWC Diversified Return Investment Team, as at 4th February 2021.
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