By Sunny Oh
Are central banks on the verge of a currency war with the U.S?
That’s the question on the minds of some investors and economists as the U.S. dollar’s decline in the year has forced central banks across the world to intervene in their own currencies at the risk of attracting the scrutiny of the new Biden administration which is eager to support U.S. factories and create manufacturing jobs.
With policy interest rates for some central banks including the European Central Bank near zero, monetary policymakers are now trying to fend off an appreciation of their currencies to support their pandemic-battered economies and maintain the competitiveness of their countrys’ exports.
“Central banks are trying to stimulate their economies and reflate. But in an environment where demand is weak and rates are low, people will turn to the exchange-rate channel,” said Nathan Sheets, chief economist at PGIM fixed income and a former Treasury official in the Obama administration.
Other central banks, particularly those in Asia, with large trade surpluses needed an outlet to invest their hoard of savings, buying dollar-denominated assets and sometimes even buying other currencies outright.
BofA Global Research estimated a 4%-5% depreciation in the U.S. dollar would historically would see central banks’ holdings of Treasurys /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y +0.23% rise by $160-$180 billion.
The ICE U.S. Dollar Index /zigman2/quotes/210598269/delayed DXY -0.11% , a measure of the greenback’s strength against its major rivals, is down 6.6% in the past 12 months, according to FactSet data.
Overseas central banks will be on their toes as more pro-labor constituencies in the Biden administration pressure the federal government to take a more aggressive stance to revitalize American manufacturers.
“The Treasury is going to be firm on countries that carry out interventions, especially to more sustained ones. The economic realities demand it, and the political realities demand it too,” said Sheets.
In Janet Yellen’s confirmation hearing for U.S. Treasury secretary , the former Federal Reserve chairwoman suggested she would take a dim view of other countries which move exchange rates away from market-determined levels.
The Treasury had labelled Vietnam a currency manipulator back in December. In addition, the Treasury has also placed China, Korea, Singapore, Taiwan, Thailand and India on their watchlist.
“Central banks in Asia are becoming concerned about rebukes and retaliation from the U.S,” wrote Shilan Shah, senior economist for Capital Economics.
It’s perhaps why some central banks including Chile and Sweden have started announcing in advance that they would start buying foreign exchange.
The Bank of Israel said it would purchase $30 billion of other currencies over the course of 2021.