King

The Fed may have a credibility problem, but like everything else in the world, it’s relative.

“Parity” headlines were plastered all over the financial pages Tuesday, as the specter of a deep German recession magnified the euro’s problems, sending the common currency to a new two-decade low (figure below).

Analysts speculated on the prospects for an overshoot (e.g., to 0.95), while others insisted parity would almost surely trigger a bounce on profit-taking and psychological factors.

To say the risks to the eurozone economy are skewed to the downside would be a good candidate for understatement of the year. That, more than anything, explains the euro’s current predicament.

Typically, you’d look to rate differentials, but that’s not the issue. “The most recent fall in EURUSD hasn’t really been rate-driven,” SocGen’s Kit Juckes said, noting that rates “helped the euro bounce in May, but since the start of June, [it’s] fallen, irrespective of rate differentials moving first in its favor and then against it.”

Europe is, in all likelihood, headed for a recession (all definitional questions aside). “It’s all about the risk backdrop and the threat to European growth from energy dependency,” Juckes went on to write Tuesday.

Another, related, issue is the ECB’s late start to rate hikes. And by “late” I mean they haven’t begun. Inflation is scorching, but the wide disparity between headline and core reflects the outsized impact of Europe’s energy woes which, in turn, threaten to precipitate an acute cost of living crisis. ECB hikes could exacerbate the situation, à la the Bank of England’s predicament.

Public faith in the BoE has crumbled. In the latest polling, the bank’s net approval rating turned negative for the first time since it gained independence. Understandably, citizens are perturbed at policymakers’ ineptitude on the inflation front, but the BoE (which hiked for a fifth consecutive meeting in June) risks amplifying households’ misery with additional tightening for questionable gain given the nature of the UK’s inflation problem.

The pound, like the euro, is beset. And although Boris Johnson’s begrudging resignation may help over the longer run, it added to domestic political uncertainty in the near-term. Notwithstanding knee-jerk price action, markets don’t like uncertainty. The pound had its worst quarter since 2008 in Q2 (figure above).

Things aren’t any better for the yen. Until the euro parity story elbowed its way onto center stage, the yen commanded virtually all mainstream FX coverage courtesy of an inexorable bout of depreciation.

The yen’s slide is, of course, the direct result of Bank of Japan policy, and specifically Haruhiko Kuroda’s refusal to widen the band on 10-year JGB yields. Kuroda’s obstinance is set against shrill protestations from market participants, many of whom insist yield curve-control (with its current settings, anyway), has become wholly untenable.

Read more: Breaking The Bank Of Japan? It Won’t Be Easy

There are fresh (or stale, depending on how you want to look at it) yen intervention headlines nearly every weekday. Today was no exception. Following a chat, Shunichi Suzuki and Janet Yellen apparently determined the yen isn’t weak enough yet to warrant coordinated action.

Kuroda’s policy posture creates a profoundly silly, albeit painfully familiar, quandary for the government. The Finance Ministry is “watching” FX markets “with a sense of urgency,” but intervening to stop the yen from depreciating when the proximate cause of that depreciation is the central bank governor comes across as farcical — slapstick, even.

A recent Kyodo poll found 58.5% of participants believe Kuroda isn’t fit for his job. However, a strong electoral showing for Japan’s ruling coalition following the shocking assassination of Shinzo Abe last week was interpreted, in part, as a public vote of confidence in monetary policy. As such, the yen sank to a new 24-year low. Kuroda won’t likely be under political pressure to abandon ultra-loose policy for the remainder of his term.

Speaking of unsustainable yield-curve control regimes, the RBA has a very real credibility problem due first to an ill-fated experiment with YCC, which the Australian central bank abandoned late last year at the first sign of trouble (the RBA’s weak-willed defense should be juxtaposed with Kuroda’s willingness to drown would-be vigilantes in yen). But it’s not just the dubious legacy of that short-lived trial that bedevils the bank. It’s also Philip Lowe’s abrupt about-face on rates.

Until very recently, Lowe clung desperately to the notion that no rate hikes were forthcoming in Australia until 2024. With last week’s move, Lowe has delivered 125bps of hikes in just three meetings, which is either an admirable example of changing one’s mind when the facts change, or else a testament to total incompetence. The RBA’s credibility hangs on which of those interpretations the public is inclined to adopt.

For their part, markets are leaning in the direction of incompetence. “Bond investors are demanding a premium to hold Australia’s sovereign debt after being burned by the central bank’s failure to provide reliable guidance on inflation and interest rates,” Bloomberg wrote Monday, in an amusing piece documenting the plight of banks’ offshore clients, who’ve “been among the worst affected and responded by shunning Australian bonds, slashing positions or moving into shorter tenors.” The Aussie tumbled Monday to a two-year low.

Given all of that, and considering the Fed’s pretensions to a near 4% terminal rate, it’s small wonder the dollar is perched at a 20-year high (figure below).

Again, it’s all relative. The Fed may be teetering precariously on the brink of a credibility crisis, but only in relation to itself.

Of course, that’s still a very disconcerting prospect, especially at a time when Americans have almost no faith whatsoever in the country’s institutions.

At the end of the day, though, you could argue there’s only one real currency in the world. “Real” is a misnomer in the sense that all currencies are figments of our collective imagination — myths, as it were. But when it comes to the strength of those myths, the dollar has no peers.

That may not always be the case, but the current conjuncture, as detailed above, suggests rumors of the king’s demise were greatly exaggerated.