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World Currency Observer
World Currency Observer

Exchange Rates: one year high and low

February 6, 2019 (see February 20 update below). Next update: March 5, 2019. Visit Search to look at past issues of World Currency Observer (brochure edition).

At the end of January, the United States Fed revised earlier statements which had suggested 2 or 3 increases in US interest rates in 2019, and these revisions have been widely interpreted to mean that there is a solid chance that these increases will not occur, despite the continuing strength in the US economy, which has pulling the US dollar up against most of the currencies of the world. WCO remarks that the US dollar has been weakening from recent peaks against several currencies around the world, since roughly the middle of November 2018, and this announcement by the Fed may lead to a broadening of this emerging trend. Note that the January 2019 developments in currencies around the world, summarised below, generally occurred before the statements issued by the Fed (but they did occur after strong criticisms by the United States President of previous indications by the Fed of interest rate increases). Developments in currency markets were also influenced strongly by the large January 2019 jump in world oil prices.

After a strong upward movement against the US$ in December 2018, the Iceland króna gave back some of the gain in January 2019, falling by 3.1% on the month. The Canada dollar was up by 4% against the US$ in January 2019, and the Mexico peso was up by nearly 3%. The Jamaica dollar fell by nearly 4% in January 2019 against the US$ and the Haiti gourde fell by 2.5%. South American currencies generally strengthened on the month against the US$, except for the Paraguay guarani (down by 1.5%) and the Uruguay peso (down 0.5%). The Brazil peso rose by over 5% in January 2019 against the US$. The United Kingdom pound moved up sharply against the US$ (perhaps based on a view that the failure of an EU deal to pass the UK House of Common means that, somehow, BREXIT really will not happen?). The Euro rose a little against the US$ on the month, and the Swiss franc fell by a little over 1%. The Hungary forint moved up by nearly 1.5% against the US$ in January, and, after many months of movement, there was little net change on the Turkey lira on the month, against both the US$ and the lira. The Russia rouble moved up 5% against the US$ in January 2019. Middle East currencies that are not fixed against the US$ moved up in January, with the Israel shekel up by nearly 3%, and the Egypt pound up by 1.5%. The South Africa rand rose by more than 7% against the US$ in January 2019. The Rwanda franc fell by 3.5%. The Nigeria naira rose by 0.7% on the month (as noted in earlier WCOs, the organisation of the Nigeria foreign exchange market, with its terminology of "windows" for various commodities and services, is increasingly looking like it will be a model for other Africa countries). The Sierra Leone leone fells by nearly 1.5% in January, and the Liberia dollar fell by 2.1%. The China yuan increased by nearly 2% against the US$ in January, and the Japan yen moved up by nearly 1%. Other Pacific Rim currencies moving up against the US$ included the Australia dollar and New Zealand dollar. The Thailand baht moved up by 4% against the US$ in January 2019, and many other Asian currencies moved up slightly. The big exception was a 2% decline in the India rupee.

The body of literature in the academic world pointing to systematic deviations from covered interest parity, based on data obtained, for the most part, from the Bloomberg organisation, continues to grow. The covered interest rate parity equation says that the future rate of a currency is anchored to the spot rate by a factor based on the interest rate differences between the two countries, with the paradoxical result that the country with the higher interest rate will see the future exchange rate registering a weakening of its currency against the spot rate. This paradox exists because, when uncovered by the future exchange rate, the interest rate difference between two countries (the carry) is an incentive for funds to flow to the higher interest rate country, pushing up its exchange rate. But, the covered interest rate parity equation is about the future rate in relation to the spot rate, not about the spot rate itself. To obtain a covered interest rate position among two currencies (such as the UK pound and the Euro), an investor can start by borrowing, say 100 Euros at a Euro interest rate of ie, so she has 100 Euros in cash, and owes 100(1+ie) when the loan/paper is due. At an exchange rate of e pounds/1Euro (the sale of the EURGBP pair), the investor acquires 100e pounds, and invests them in a UK instrument paying iuk, so she will receive 100e(1+iuk) when the instrument matures. At maturity, she must sell her 100e(1+iuk) pounds, converting back to Euros at 1/e (the exchange rate at that moment) and settle her 100(1+ie) Euro debt. Among the variety of exchange rate outcomes, if the exchange rate at maturity remained at e, she has made a Euro profit from her uncovered position. If she wants to totally avoid possible losses due to exchange rate movements, she can obtain a futures/forward contract which reverses the initial exchange rate – she started by selling Euros and buying pounds in the spot market, so, at the same time, she does the reverse in the futures/forward market, buying Euros and selling pounds for delivery at maturity. Covered interest rate parity says the futures/forward exchange rate will be such that the profit from the above transactions (and, from their reverse, starting in pounds) will be zero. Whatever the predictive power of the covered interest rate parity equation for aggregate data, it is used to price individual foreign exchange swaps, which are simultaneous (very short-term) spot sales and forward purchases of a foreign currency. Foreign exchange swaps are used by banks and multinational corporations to fund liquidity needs, and the large size of the amounts involved and the shortness of the terms (meaning they are entered into frequently) means that they are, in volume terms, the largest single type of trading in foreign exchange markets. Aside from their important role as support for short-term needs for banks and multinationals, the economic significance of these large volumes is very small, because they are very short-term and are always being reversed. Also, the interest rate opportunities they reflect are only available to very large amounts of money, as well as the bid/ask spreads and commissions which are low enough so they do not eliminate the interest rate differences. But their existence is important, one reason being they are part of the process by which foreign exchange markets assimilate new information and move exchange rates towards levels that appropriately reflect the economic and financial realities for particular countries, and of the world in general.

February 20, 2019 update

 Belarus rouble and Russia rouble February 2019

Belarus, along with Ukraine and the three Baltic states, are the countries which are between Russia and other European countries (and through which Russia must ship its oil and gas exports to its main European Union customers). There have always been exchange rate issues between Belarus and Russia, as it is generally agreed that Belarus would have been content if the former Soviet Union had not broken up in 1989, so a Belarus goal has been to maintain links with Russia, which was embodied in the 1997 Union State agreement between Russia and Belarus, the intent of which was to maintain and strengthen ties between the two countries, including a desire to, some day, implement a common currency. After many years of turbulence in Belarus following the breakup of the USSR, including a period of hyper-inflation and many years of parallel exchange rates, the exchange rate between the Russia rouble and the Belarus rouble has been stable since the beginning of 2012, a period that includes the 10000:1 Belarus redenomination in July 2016 (the exchange rate is currently around 3.3 Belarus roubles per 100 Russian roubles, and the National Bank of Belarus tracks a basket of currencies, which is 50% Russia roubles, 30% US dollars and 20% Euros). But one hangover from the years of turbulence is the Belarus is generally believed to be the most highly dollarized country in the world, with perhaps seventy percent of bank loans and deposits denominated in foreign currencies, principally the US dollar, and the process of unwinding from dollarization takes time – in the short run it is possible to put in place incentives for depositors and lenders to convert to the domestic currency, but another hurdle is the existence of many contracts that are denominated in US dollars and other foreign currencies. A major bilateral issue is that Russia is winding down its former practice of providing natural gas and oil to Belarus at below-market prices, for a number of reasons, in part because there has been evidence of resales by Belarus of oil and gas on world markets, but also possibly because Belarus has been more open in the past few years about a desire to maintain its autonomy with regard to Russia, such as recently ruling out any possibility of unification of the two countries (there are many who view the recent oil and gas crackdown by Russia as entirely motivated by Russia desire for hegemony in the region).

(World Currency Observer will next be updated on March 5, 2019. Visit Search to look at past issues of World Currency Observer (brochure edition).)