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3 lessons from the current global tightening cycle to apply in the FX market

The New York Exchange Wall Street

One major central bank announced its monetary policy this week – the Reserve Bank of New Zealand. It moved the cash rate to 4.75%, raising it by another 50bp.

Yet, the New Zealand dollar barely moved. In fact, the price action was so depressed that, in the end, the Kiwi dollar, as it is also called, declined against the US dollar.

This is surprising, given that the Fed hiked only 25bp in February compared to the RBNZ’s 50bp. So what is the reason for that?

The answer is well-known and a global phenomenon – inflation.

Because of that, it is a good time to put things into perspective and look at the bigger picture. So what lessons can we draw from central banks’ actions in 2022 and 2023, and how can we apply the findings in the FX market?

Inflation is a global phenomenon

The picture above speaks a thousand words. Inflation is a global phenomenon, as it has reached levels not seen in decades in advanced economies.

Sure enough, people are familiar with inflation rates like 57.7% in Turkey or 98.8% in Argentina. Money is losing value overnight in those places, and all central banks can do is raise interest rates.

But raising the rates does not solve the problem. The idea is for the central bank rate to exceed the inflation rate. Thus, a positive real interest rate can be achieved.

There’s no positive real interest rate in advanced economies

Yet, of all the countries listed above, only in a few ones there is a positive real interest rate. And none of them has an advanced economy.

In other words, investors looking for real yields are invited to park their money in exotic currencies, such as the Brazilian real. But are they willing to leave the safety of advanced economies’ currencies despite a negative real interest rate? Most likely, the answer is no.

Japan stands out from the crowd

2022 was the year when the Japanese yen (JPY) pairs broke higher. All of them did, with no exception.

The rally was so aggressive that the USD/JPY exchange rate moved from 116 to 152 in just a few months. That is a gigantic move, but one that can be explained by the picture above.

Japan is the outlier.

The last time it moved rates was in 2016, and it cut them. Hence, it goes against the global tightening cycle despite inflation being above the target.

It tells us that there is more room to the downside for the JPY should the monetary policy in Japan remains unchanged.

The post 3 lessons from the current global tightening cycle to apply in the FX market appeared first on Invezz.

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