As the signals reinforcing the belief that a “Shanghai Accord” was indeed agreed by the world’s largest central bankers are becoming more obvious, currency markets – and financial markets in general – are being influenced by a currency conflict that no one quite knows which direction will take. Things are likely to become clearer this week, though.
In the currency wars, in which strangely the winners are those who lose the most, there is currently a conflict between the EUR and JPY vs. the CNY – with the USD right in the middle. The equation is quite simple:
- Europe and Japan will very quickly implode if the EUR and the JPY stay as strong against the USD as they have recently been. Their fundamentals are horrible, but, ever since the day of the presumed “Shanghai Accord”, the Fed came out to talk down the USD, effectively sending it lower against the EUR and JPY – although the USD’s fundamentals are far better than those of the EUR and JPY.
- China also needs a weaker CNY against the USD, because it needs to boost its exports and find a way to deal with its CNY strength and the way it can affect its over-leveraged banking system and over-capacity economy. So far, since this presumed “Shanghai Accord” happened, China is winning this conflict, because a weaker USD also means a weaker CNY, since it’s pegged to the USD.
With the DXY mostly trading in an undefined range in the recent weeks, this question is still to be answered. Who will win this currency war? We will probably get new signals this week that will help us understand what is likely to happen. Still, one thing is certain: this is a dangerous game of open currency manipulation that central bankers are playing – and that the markets may disrupt at any time.
In the face of all this, Ridge Capital Markets advises traders to be cautious in this scenario – which is not led by fundamentals or technical patterns, but by policy decisions. We believe that the Fed has placed itself in a situation from which there is no clear way out. Nevertheless, we believe that China will ultimately have to devalue the CNY quite a lot more, regardless of what the Fed does, and that, be as it may, the Fed will be increasingly pressured to relieve the EUR and the JPY from their strength.
There is one recommendation that we can make in this scenario, though. If the DXY goes below 93 or 92.50 and doesn’t rebound immediately, it may be time to short the USD and go long gold and other currencies. After all, despite the fundamentals, it is true that “the market can stay irrational longer than you can stay solvent."