Iskandar Najjar CEO Alpari ME DMCC

1. Resistance is futile As nations compete for export-led growth, central banks are facing increasing criticism for manipulating their domestic currencies. The rationale behind currency manipulation makes sense, but in an increasingly globalised world is competitive currency devaluation viable? Iskandar Najjar CEO Alpari ME DMCC

2. Rationale • If an economy is seeing strong growth, its currency will tend to strengthen • Expectations of higher interest rates push up FX rates • This acts as a natural brake/stabiliser • stronger currency tends to raise imports, helping to slow GDP growth • Weaker exchange rate usually improves • Export volumes • Increases GDP • A situation where the domestic currency is rising but GDP is not growing / contracting • Switzerland • Japan • Politicians and policy makers can give into temptation and attempt to artificially devalue domestic currency • Boost growth • Avoid deflation

3. Artificial intervention • • Currency intervention is possible and likely • Swiss National Bank (SNB) • Bank of Japan / Ministry of Finance (BoJ/MoF) • Central Bank of Brazil (CBB) • People’s Bank of China (PBoC) • • JPY selling intervention is conducted by issuing financing bills • attracting funds from the market using the same funding structure as normal fiscal spending • As a result, the BoJ/ MoF are trying to drive USD/JPY higher by expanding the Japanese fiscal deficit • • Currency devaluation via the back door • loose monetary policy • QE

4. Effectiveness of intervention • The Effect of intervention can be judged by • Measuring short-medium term change in spot exchange rates. • Intervention is most effective when: • Unsterilized i.e. actively adding to the money supply • Done multilaterally with other nations • Accompanied by complementary monetary policy changes in the respective countries • A ‘defensive’ intervention intends to prevent a sharp fall/rise. • Prevention of a sizeable fall/rise that would have happened without intervention • An ‘aggressive’ intervention intends to drive the exchange rate down/up to a particular point. • Success = spot FX rate falls/rises to a desired point

5. Case study: Japan in the 1990’s • • There have been two instances of relatively large and sustained JPY selling interventions in the past: • Mid-1990s • During 2003-2004 • The large-scale interventions in the mid-1990s began on April 2, 1993 when USD/JPY fell from the 114s to the 113s. The noteworthy point is that USD/JPY continued to fall even as the JPY selling intervention continued and rate of JPY strength INCREASED as Bank of Japan / Ministry of Finance increased USD purchases JPY started to weaken via market forces soon after intervention stopped

6. Case study: Japan in the 2000’s • The large scale interventions undertaken during 2003-2004 began on Jan 15th, 2003 as USD/JPY fell from 118s to 117s. • The string of interventions lasted 14 months, ending Mar. 16th 2004. • Overall impact was USD/JPY fell from 118s at the start of intervention to 105s at the end. • USD/JPY bounced up to 114+ shortly after the END of intervention measures. • JPY again appreciated throughout interventionist measures The phenomenon of JPY appreciation stopping as soon as intervention stops suggests intervention is completely counter-productive The more the BoJ/ MoF sell JPY, the more it appreciates against USD

7. Ineffective intervention • Large volume of USD sell orders sprung up not long after the start of JPY selling intervention, in both 1993 and 2003 intervention stints • VERY PRIDICTABLE/TRADEABLE • Any artificial adjustment attracts purely speculative interest via media focus and serialisation because intervention occurs periodically • Intervention is usually done quickly so spikes are sold into, dips are bought up • Influential market participants realise that in the case of FX intervention, going against the central bank tends to be the most effective strategy • LOWER VOLATILITY • Bouts of intervention are usually accompanied by lower volatility allowing large market participants to avoid trimming large positions and/or allow carry of larger positions • HIGHER LIQUIDITY • Central bank intervention creates ample liquidity • Intervention in 1993 and 2003 was accompanied by a cheap US Dollar • Liquid markets attract speculators which adds to burden facing central bank • PSYCHOLOGY • A visible target is inevitably shot at

8. Side effects of artificial intervention • Weaker Yen tends to lift Japanese stocks • High export sensitivity of Japanese firms • Higher fiscal deficit • Floating FX loss if intervention fails • MoF comments are usually more market receptive compared to BoJ • Spike in media interest and speculative trading intentions • Intra-day volatility can seriously damage short-term trading strategies

9. Conclusion • Artificial intervention rarely works • Aside from causing short-term spikes against the prevailing trend • Conducting JPY selling interventions has opposite effect • Further enhancing Yen strength • JPY selling intervention • does not get to the root of the problem and only helps to increase foreign reserves in vain • Instead of hollow policies that attempt to bandage the wound, • what is required are policies that fundamentally boost domestic demand and reverse deflation

10. SNB intervention in 2009/ 2010 1.50

11. Better luck next time? • Despite history not being on their side, central banks still intervene in FX markets • Prime contenders are: • Japan (USD/JPY) • Switzerland (EUR/CHF, USD/CHF) • Brazil (USD/BRL) • CHINA (USD/CNY) • Historic low in USD/JPY is 79.75. Current rate is 81.90 • US recovery is gathering momentum ---> a natural path for USD/JPY appreciation • Japan is unable to conduct aggressive intervention considering criticism from other G20 nations. • Some reports suggest the BoJ/MoF have been actively defending the 80 level in USD/JPY but have been disguising market operations to prevent media attention and more speculation • Swiss National Bank (SNB) could act given current historic lows in EUR/CHF and USD/CHF

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