Headline for .     The US dollar has strengthened against a broad range of world currencies since the start of 2018.     WORLD CURRENCY OBSERVER thanks readers for comments. In any language, on any topic, send them to renaissance@briargreen.com.    
World Currency Observer
World Currency Observer

Exchange Rates: one year high and low

August 4, 2020 (August 19 update below). Next update: September 2, 2020. Visit Search to look at past issues of World Currency Observer (brochure edition).

The degree of “success”, by each country, in keeping down the number of coronavirus Covid-19 cases appears to continue to be the strongest influence on the strength of individual currencies against the US$. Currencies have generally gone up against the US$ since the pandemic caught hold in the middle of March, reducing, for example, the need for central bank currency swaps in order to obtain US dollars. There is a perception that the strength of stock markets (measured from the depths reached in the middle of March 2020, not/not from the beginning of 2020) and real estate markets around the world (and also US$ prices for hard commodities, such as precious and industrial metals) is based, somewhat, upon a general hope for a successful recovery of the world economy from the pandemic (no telling how long it will take), but even more so, upon the influence of monetary stimulus - downward pressure on interest rates (which are now almost as low they can go in most countries), and central bank-directed purchases of the highest quality bonds and debt, which have been augmented to include a wider variety than usual of non-governmental bonds.

For the last couple of years, the WCO marquee headline (flashing above) has said: “The US dollar has strengthened against a broad range of world currencies since the start of 2018.” Update: WCO remarks that the above statement remains true, so far, despite the recent (and continuing) weakness in the US$. The exceptions (countries whose currencies have not shown net downward movement against the US$ over the period since the start of 2018) include: Trinidad and Tobago, Bolivia, Suriname, Switzerland, Albania, Armenia, Azerbaijan, Moldova, Bahrain, Egypt, Israel, Morocco, Japan, Philippines, Thailand; and the broad range of currencies which are fixed against the US$, such as in the Caribbean, the Middle East, and some central Asian currencies which were part of the former USSR - countries with fixed currency exchange rates have, however, often seen greater declines in their US$ exchange rates in parallel markets (such as Iraq – see this week’s New York Times Magazine on how the Iraq foreign exchange auction has been manipulated, partly to take advantage of the parallel-official spread). Among the exceptions, their net upward movement against the US$ has generally been small over the 2½ year period since the beginning of 2018, particularly in contrast to the sizeable downward movements against the US$ of the many other currencies. Events which have occurred over the period since the beginning of 2018 include: the strong and continuous recovery of the US economy, until the coronavirus Covid-19 pandemic caught hold in the middle of March (4½ months ago); the ongoing trade war between the United States and China, and the collapse in world oil prices.

The North America currencies moved up against the US$ in July, but still remain below their level at this time last year – for example, the Mexico peso, was up by 4% in July against the US$, but down by 17% since this time last year. After its strong rise in June, the Jamaica dollar fell by just over 5% in July against the US$, and is down by 7% since this time last year. The Trinidad and Tobago dollar was steady in July against the US$. The Brazil peso was up by nearly 5% in July against the US$, but is down by nearly 40% since time last year. The Chile peso was up by7% in July, and the Argentina peso was down by 3% against the US$ in July. The Euro continued to rise in July 2020 against the US$, up by 5%, and is now up by nearly 6% against the US$ since this time last year (will this upward rise continue?). Other European currencies also strengthened against the US$ in July, with the oil-price-linked Norway krone up by 6% (but still down by 3.5% against the US$ since this time last year, which is unlike all other European currencies, which are up since last year against the US$). The United Kingdom pound was up by 6% against the US$ in July. The big exception to the upward movement in July of Europe currencies was the Turkey lira, down 5.5% on the month against the Euro, and down 25% against the US$ since this time last year (see the paragraph below). The Russia rouble, the Ukraine hryvnia and the Kazakhstan were all down by around 4% against the US$ in July - the Russia rouble is down by 14% against the US$ since this time last year. The Iran riyal was down by 14% in July, after a larger fall in June; other Middle Eastern currencies were generally stronger against the US$ in July. Africa currencies were generally up against the US$ in July, but were down against the Euro (but the CFA franc, pegged to the Euro, was up by 5% in July against the US$.). The Nigeria naira weakened a little against the US$ in July. The Ghana cedi rose by 0.5% in July. The Japan yen was up by 2% against the US$ in July, and is up by 3% since this time last year. While other Asian currencies were generally stronger against the US$ in July (among these was the 1.5% rise in the Philippines peso, up 3.5% since this time last year), the Indonesia rupiah was down by 2.5%, and the Thailand baht (generally regarded as having showed a lot of strength in the last few months) fell by 0.5% in July. Metals prices were generally up in July, but the metal attracting the most notice was silver, with its US$/oz price up by 35% in July, interpreted by some commentators as a correction of the recent wide gap (by historical comparison) with the price of gold, which opened up when the price of gold moved up by nearly 40% since this time last year. Oil prices rose by 7% in July, but are 30% below their level at this time last year. Rice prices, in US$ terms. were down by 7% in July, and are up by 14% since this time last year.

 Russia rouble and Ukraine hryvnia August 2 2020

As noted above, the Turkey lira fell in July. (A reminder of the diversity of Turkey, including the fact that it has territory in Europe, but also shares borders with Iran, Iraq and Syria, and shares an inland ocean with Russia and Ukraine.) The Turkey inflation rate is around 12.5%, and its inflation-adjusted interest rates are perhaps the lowest in Europe (for example, the benchmark 1 Hafta Repo rate is currently at 8.25%). In March, the Turkey central bank (TCMB) reduced, by 500 basis points, the percentage of foreign exchange reserves that financial institutions were required to hold (at the central bank) against their foreign exchange deposits, thus allowing banks to reduce their foreign exchange deposits with the central bank. This led to some market comments that this would turn out to be mistake, and that, combined with central bank intervention in the foreign exchange market, the result would be an unsustainable fall in Turkey foreign exchange reserves. The Turkey central bank, however, subsequently made some offsetting moves – an increase, from US$5bn to US$15bn in the size of its US$ swap agreement with the central bank of oil-rich Qatar; and, in June, first use of a China yuan swap arrangement with the China central bank. Then, in mid-July, the central bank announced a partial reversal of the March drop in the foreign exchange reserve requirements, raising it by 300 basis points, thus requiring more bank deposits of foreign exchange with the central bank. Indications are that, cumulatively, these measures (and others) worked, and that the Turkey foreign exchange reserve position was preserved.

August 19, 2020 update

Among the news regarding international borrowing around the world during the Covid-19 pandemic, Argentina is said to be close to a restructuring of $66bn of its international debt which has been in default (which will open the gateway to international borrowing markets again by non-government Argentina borrowers); and Ecuador (which uses the US dollar as its currency) has also reached deals with creditors on over US$17bn of its debt, but with several expressions of views that, despite the pandemic, a better deal could have been reached.

The parallel market rate (Tripoli-based) for the Libya dinar has moved down since the start of 2020, from around 4/1US$ at the start of the year, to 5 at the beginning of April 2020, to 6 at the beginning of May, and is currently at around 6.25 dinars/1$US. The official Central Bank of Libya (Tripoli) rate for the dinar is at around 1.37 (midpoint). Libya is divided by a civil war marked by international intervention on both sides of the conflict, one result of which has been difficulties in selling oil from the vast Libya oil reserves. Among the consequences of the civil war is that Libya has a 2nd central bank, the Benghazi Central Bank, based in Tobruk, but with less access to world financial markets than the Tripoli central bank. The Benghazi Central Bank has printed and issued its own Libya currency (said to have been printed in Russia) and, while it is used, it is treated as counterfeit in many parts of the world outside of Libya.

The interest rate parity equation formalizes the link among exchange rates (spot and outright/forward) and interest rates (modified by the so-called “basis”), and is applicable in a variety of situations, which makes it one of WCO’s favorite tools for analysis of and insights into foreign exchange markets. One of these insights is that equation highlights the importance of borrowing and lending in the determination of the spectrum of exchange rates (spot, forward, futures, puts and calls), suggesting why banks, with their access to the lowest cost pools of funds and their participation in markets for very short-term funds (their need for reserves against foreign currency liabilities, for example), are the financial institutions which naturally dominate currency trading. And even where the equation breaks down (the “basis” added to US$ Libor, which is usually the benchmark for the US$ leg of currency transactions), this is because it indicates relative levels of demand for the two currencies involved, so the equation is a good place to start analysis. By manipulating and elaborating the equation, one can price forward exchange rates (the “outrights”) and foreign exchange swaps (kind of like the “repos” of the foreign exchange world). It crystalizes the idea that, if you are comparing borrowing in one currency with borrowing in another, you have to take into account currency movements over the lifetime of an investment (e.g., it shows why the low interest rate Swiss franc mortgages in the 1980s did not mean they were necessarily going to turn out to be cheap). Depending upon what you want to analyze, the interest rates you use can be the ones that are specifically available to you or your firm (for analysis of a particular transaction), or can be the well-published benchmarks, such as the LIBOR interest rates for different currencies, which are used to set market forward and spot rates, and which gives F-S, the deviation of market forward rates from market spot rates, to derive the cost of foreign exchange swaps (the movement from specific to general is analogous to the way that the purchasing power parity equation can be used as a tool for one good or service, or for an entire economy, remembering that interest rate/exchange rate markets clear in an instant, while goods markets in purchasing power parity analysis can take months or years to totally clear). The equation can also be used to analyze the cost of the easiest foreign exchange hedge, the “natural” hedge: if you “live’ in a pound world, and you owe US$1000 in three months, then convert to US$ today and put it in a US$ money market instrument for three months, and you are (almost perfectly) hedged.

The variables in the interest rate parity equation: S = spot pounds per 1$US (1/S is “cable”), which can be bid or ask, depending on what you are analyzing; F = forward (outright) spot pounds per 1$US, also can be bid or ask; iP = the pound interest rate (lending/depositing or borrowing, depends upon what you are analyzing); iU =the US$ interest rate (lending or borrowing); “1”, which is denominated in the home currency, 1 pound in this example; * indicates multiplication but also sequential foreign exchange conversions; / indicates division and also conversion of the top currency to the bottom (“per”); and b is the basis, the interest rate premium that may have to be paid because of a “scarcity” of US$. The equation can be expressed in many ways, but you can start with S*(1+iP)/(1+iU+a)=F, which gives a nice natural relationship between the spot rate and the forward rate, because you multiply the number of pounds by the pound interest rate (which can indicate repayment, in, say, 1 month, of 1 borrowed pound); and the number of US dollars (which is 1/S) is multiplied by the US$ interest rate plus the basis (which can indicate receipt of US dollars that have been lent). You can go “backward” as well, taking the present value of the top and the bottom of the forward rate, to derive the spot rate from the forward rate. The transaction which is most well-known is the above-mentioned foreign exchange swap, where you first convert pounds into US$ at 1/S, hold the US$, and then convert them back into pounds at F. You can adapt the equation to tell a narrative about the cost of borrowing US$ in the United States (instead of borrowing directly in pounds), converting the proceeds to pounds, and then converting back to US dollars to make your repayment (called direct versus synthetic pound borrowing by some); to analyze cross currency swaps, where you borrow in your home market, I borrow in mine, and we exchange the amounts borrowed and the associated interest payments (mostly off-balance sheet, if you don’t believe in reading footnotes); or even the medieval bill of exchange, when you could lend today in one currency and get repaid 3 months later in another city and in another currency at a specified exchange rate (with no mention of the underlying, and illegal/sinful, rate of interest charged), and then, as a lender, hope that you could find a bill of exchange transaction going the other way, so that you could get repaid in your home currency and book your profit. (Later on, WCO will talk about other equations which are rich in predictive and analytic power, including: purchasing power parity, and the Black-Scholes equation for the pricing of foreign exchange puts (right to sell a currency), calls (the right to buy currencies) and so on.)

(Addendum posted September 19/20.) An illustration of how a foreign exchange swap can be constructed. Begin with a spot purchase of 1 US$ of foreign exchange, which a purchaser (in the United Kingdom) wants to hold for a short period of time (say, 1 month), and then to reconvert the 1 $US to pounds at a pre-determined rate of exchange. After the spot purchase, the purchaser does another transaction: the purchaser borrows (see below) 1/(1+iU) US dollars, converts them to S*(1/(1+iU)) UK pounds, which he then loans out at an interest rate of iP. At the end of the month, the purchaser will receive (1+iP)*S*(1/(1+iU)) in UK pounds, while paying back the 1$US owing on his US$ loan (taken out at an interest rate of iUS) - the amount of this pound-for-US$ exchange is the forward rate. Of course, an average individual purchaser would pay too much for the US$ loan, and not be able to obtain the best pound interest rate, so will not get as may UK pounds per US$ as would be possible from, say, a bank or from another financial institution active in wholesale financial markets, who can obtain better interest rates, and therefore can sell the pound forward for US dollars at a better rate.

(World Currency Observer will next be updated on September 2, 2020. Visit Search to look at past issues of World Currency Observer (brochure edition). For permission-to-quote enquiries, e-mail World Currency Observer at WCO@briargreen.com.)