Photographer: Xaume Olleros/Bloomberg

Intervention Loses Potency Just as Currency Wars Seen Escalating

  • Krona stronger versus most peers as Sweden considers action
  • China's devaluation prompts central banks to weigh responses

As a new round of competitive devaluation looms, evidence is mounting that currency interventions are losing their potency.

Mexico’s peso fell to a record as Cantor Fitzgerald LP criticized the nation’s efforts to strengthen the exchange rate as “mostly futile.” A study by Brazilian central bankers last week found “no evidence” that their intervention program was affecting currency volatility. And far from driving a sustained decline in the krona, mooted sales by Sweden’s Riksbank may actually be a buying opportunity, according to Citigroup Inc., the world’s biggest foreign-exchange trader.

China’s efforts to depreciate the yuan have raised the stakes as other nations seek to weaken their own currencies to stay competitive or strengthen them as a plunge in commodity prices ravages their citizens’ buying power. Mexican Finance Minister Luis Videgaray said Jan. 7 that the world’s No. 2 economy risks triggering competitive devaluations -- known as a currency war-- while Sweden put in place measures that will help it step in to curb the krona’s gains and boost inflation.

“There’s a big question mark over the ability of individual central banks -- particularly for small, open economies -- to really influence exchange rates through intervention in anything other than a short-term perspective,” said Ken Dickson, the Edinburgh-based investment director for currencies at Standard Life Investments Ltd. ,which manages about $360 billion. In Sweden’s case, “it’s very difficult for the central bank to fight the market if it wants to go the other way."

Still Stronger

While the krona has declined more than 1 percent versus the euro since the Riksbank said Dec. 30 it was ready to intervene, it’s stronger against most other major currencies. Minutes of the central bank’s December meeting, published Friday, showed a number of policy makers said intervention may be necessary.

Standard Life’s Dickson expects the krona to gain versus the euro, and the median forecast in a Bloomberg strategist survey is for an advance to 9.2 per euro this quarter, from 9.28 on Monday. The krona will strengthen, with a gain to about 9.1 a likely trigger for intervention, “but not a floor,” London-based Citigroup analyst Josh O’Byrne wrote in a Jan. 8 report.

It’s almost a year to the day since the cost of intervening to weaken the franc prompted Switzerland to scrap its exchange-rate ceiling for a mixed policy of franc sales and negative interest rates. Yet its currency is still 10 percent stronger than the 1.20-per-euro limit it was forced to abandon.

Ending the cap reverberated around financial markets -- just as China’s devaluation is doing now.

Pushing Luck

“It’s very difficult for a central bank to sustain an artificial foreign-exchange rate for an extended period of time,” said Peter Rosenstreich, head of market strategy at Swissquote Bank SA in Gland, Switzerland. “We saw that very clearly in Switzerland, in a very scary, dramatic sense: what happens when you extend your good luck too long. It’s generally extremely expensive and doesn’t work out particularly well.”

Nations across the developing world stepped back from currency intervention last year, embracing the boost to exports a weaker exchange rate tends to bring and easing pressure on their foreign reserves.

Many of the interventions happening now are to boost currencies rather than weaken them. Colombia’s central bank governor said last month it was getting closer to the conditions where it might need to step in after the peso slid to a record. Brazil’s real has fallen almost 2 percent against the dollar since September, when policy makers resumed sales of swap contracts and credit lines to support the currency.

‘Futile’ Attempt

Mexico’s peso has slumped 18 percent since the nation began its latest intervention program in December 2014. Rafael Elias, head of emerging-market strategy at Cantor Fitzgerald in New York, wrote in a report last week that the “daily interventions are proving to be mostly futile, and the depreciation is only partially reduced with these dollar sales.”

Surprise and coordination are key to intervening successfully, according to a 2015 paper by Harvard University Professor Jeffrey Frankel. The report examined the history of interventions since the 1985 Plaza Accord, a coordinated effort by the U.S. and other countries to weaken the dollar. It argued that the strategy is doomed to fail if markets are determined to move a currency in the opposite direction.

Joint action is no guarantee of success. An attempt by Japan and nations including the U.S. to weaken the yen after the tsunami and earthquake of 2011 spurred only a fleeting decline in the currency, which strengthened against all of its major peers over the next two months.

More distant history also shows the challenge of going against the tide. In 1992, the U.K.’s inability to stave off speculative attacks on sterling forced it to pull out of the European Exchange Rate Mechanism, a precursor to the euro.

“There are episodes where speculative market pressure is basically larger than the willingness, or ability, of the central bank to rule against it in terms of intervention,” said Ulrich Leuchtmann, head of currency strategy at Commerzbank AG in Frankfurt. “The pound was a good example.”

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