Stock markets have steadied in Asia and early European trade on Tuesday but that is not reflective of the mood in the markets at the moment so it may struggle to hold.
The volatility in FX markets at the start of the week has been extreme but it’s also been building for weeks as authorities desperately try to arrest the decline in their currencies, particularly against the US dollar.
On Monday it was the UK that was front and centre following the mini-budget on Friday that showed total disregard for the environment in which it was being implemented. Promising much higher borrowing to fund huge tax cuts at a time of double-digit inflation that hasn’t even peaked is beyond bold and the backlash is well underway.
There’s nothing wrong with being ambitious on the economy but timing is everything and when the cost is much higher interest rates, there won’t be many winners and the economy simply won’t see the benefit. The question now is whether the pressure both externally and from within will force a rethink in order to settle things down.
The Bank of England did little to help. After speculation all day of an impending announcement, the central bank only sought to reassure markets that they stand ready to act but probably not until the next meeting in early November when it is armed with new macroeconomic projections. Needless to say, that reassured no one and sterling plummeted again after recovering amid the rumours of the announcement.
BoJ intervenes amid rising yields
It’s not just the UK that’s contending with a haemorrhaging currency, the Japanese Ministry of Finance was forced to intervene last week for the first time in 24 years in order to support the yen. Of course, while the UK’s problems appear largely self-inflicted, Japan is suffering as a result of a growing rate divergence that is worsening month to month.
So much so that the Bank of Japan was forced to intervene itself overnight with another bond-buying operation to the tune of 250 billion yen. The problem with yield curve control is that when yields are rising everywhere, pulling those in Japan with them, the upper limit is frequently tested necessitating intervention which in turn weakens the currency. It seems Japan is now stuck in an intervention doom loop until central banks elsewhere see peak inflation and therefore rates, or the BoJ loosens its grip and allows yields to move a little higher.