Currency Pegs Coming Unhinged

Market Trends - 07/09/2015

For one reason or another, many countries are forced to peg currencies in an effort to keep exports competitive and prevent conditions that could eviscerate an economy. The most widely known peg is the US dollar versus the Chinese Yuan (USDCNY) which has come under considerable pressure lately after the Chinese move to devalue in an effort to prop up ailing growth in the economy. The substantial ascension in the US dollar over the past year has created a situation in which currencies pegged to the dollar also rise, making their exports less competitive, especially in the case of China. Now that countries are attempting to abandon pegs and devalue, the next leg of the currency war is underway as more countries are forced to reevaluate the costs of maintaining fixed exchange rates. The Swiss National Bank was the first institution to fold as the costs of maintaining the Euro peg soared with balance sheet losses at the highest level on record. Fortunately for the SNB, they can afford to take some losses on their Euros subsequently opting for a softer peg.

Other countries may not prove as fortunate as the Swiss or Chinese when it comes to abandoning longstanding currency pegs. In particular, there is growing concerns that Saudi Arabia will succumb to the pressure of one of the largest budget deficits in recent history hampered further by the steep decline in oil prices. The reference rate currently stands at 3.75 Saudi Rials to 1 US dollar. While a devaluation would certainly impact purchasing power, specifically for the nation’s imports, it would reduce expenditures and also free up valuable funds in Rials that are otherwise being drained by the high dollar valuation. The other notable currency peg in place for decades is the Danish Krone peg to the Euro. The Central Bank has taken many steps to avoid the current currency war from pushing the Krone higher, owing to the nation’s fiscal discipline and necessity to stay competitive in the global economy. While the balance sheet has gradually fallen thanks to fewer interventions negative interest rates, should the recent rise in the Euro reverse owing to a turn in Europe’s fortunes or conversely expanded asset purchases, the pressure might force the Danish Central Bank to capitulate, causing EURDKK to tumble.


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