Analysts: No Fed Taper Reignites Risk of Currency War

Thursday, 19 Sep 2013 11:08 AM

By Michelle Smith

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By deciding not to taper its stimulus programs the Federal Reserve has reignited the risk of a currency war, analysts tell CNBC.

A potential currency war was a hot topic earlier this year, but one rarely discussed in recent months. The hype blew over when nations defied expectations by not over-reacting to Japan's aggressive monetary policy decisions.

But analysts warn that the Fed's decision to continue its bond-buying programs will likely reinvigorate the conversation.

Editor’s Note: Forbes Columnist: ‘Who the Hell Cleared This?’ (See Shocking Video)

"We are on the verge [of a currency war] ... especially if the Fed does not taper in October or December," Boris Schlossberg, managing director of BK Asset Management, told CNBC.

Despite spotty economic data, Barron's says nearly two-thirds of market participants expected the Fed to taper.

In the months ahead of Wednesday's Fed meeting, investors dumped "riskier" assets, such as emerging market currencies, and flocked to the dollar. When the Fed announced Wednesday it would not taper its asset purchases, there was immediate market reaction and the dollar tumbled.

Barron's says the fall was exacerbated during Fed Chairman Ben Bernanke's press conference as he set a more dovish tone by indicating the central bank may not do any tapering in the near term.

"This sets up a situation where the dollar could end up in a protracted downtrend," Shahab Jalinoos, a currency strategist at UBS, told Barron's. "This is unmitigated bad news for the dollar," he said.

It's also a driver for currency appreciation around the globe.

"All major pairs with the U.S. dollar are running hot, with AUD/USD [Australian dollar/U.S. dollar] the strongest performer up 1.8 percent in the U.S. session and EUR/USD [euro/U.S. dollar] not far behind. This does raise the question, what will be the responses from other central banks?" Evan Lucas, market strategist at IG, told CNBC.

The Reserve Bank of Australia is already expected to lower interest rates by year-end and Lucas believes it will be one of the first central banks to respond to the Fed's decision.

Schlossberg says the situation will put pressure on G10 countries and they will have to react. Those nations only have one option — "even more accommodative policies in order to try and equalize all these currency differentials," he told CNBC.

Though the yen strengthened, the move was less dramatic than that of some other currencies. Schlossberg claims that is an indicator that the markets are looking for Japan to be the first to retaliate. And he believes the Bank of England is likely to follow suit.

Lucas agrees the Fed has presented Japan with some tough questions.

"The fall in the USD [U.S. dollar] is dire to its [the Bank of Japan's] stimulus plans for the yen and the broader Japanese economy. Will the Bank have to intervene again? Will the three arrows be ramped up?" he asked.

Editor’s Note: Forbes Columnist: ‘Who the Hell Cleared This?’ (See Shocking Video)

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