Morning Commentary: Bretton Woods is Alive and Well

Foreign Exchange - Morning Commentary
Bretton Woods is Alive and Well
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Alan Rose
Alan Rose
Foreign Exchange Senior Trader
For those not well versed in the history of the foreign exchange markets, the Bretton Woods Agreement in 1944 set up a system of rules, institutions, and procedures to regulate the international monetary system. Beggar thy neighbor polices, tariffs and competitive devaluations made the Depression that much worse and this new framework was to prevent those negative developments from reoccurring.

The U.S. dollar replaced the British pound as the reserve currency of the world and established a fixed exchange rate system with currencies pegged to the U.S. dollar and backed by gold. Global currencies traded in an extremely narrow band from 1945 to 1971. This system came to an end in 1971 when the U.S. terminated convertibility of the U.S. dollar to gold and currencies of the world became free-floating where intraday volatility could regularly spike from two to three percent.

In the short term, there has been an enormous amount of geopolitical tension, central bank activity, trade wars, Brexit, etc. that should keep global currencies active along with heightened volatility; the exact opposite is occurring. The euro, the next most important currency to the U.S. dollar, has traded between $1.1000 and $1.1100 for the past thirteen sessions. The JP Morgan FX volatility index has collapsed since the beginning of September and barely budged after the attack on the Saudi Oil fields which set off a chain reaction through all asset classes but subsided very quickly.

Too much uncertainty combined with random price action is paralyzing investors for now. As September winds down, a new month is around the corner. The month of October has a long history of market turbulence and while no one wishes for extreme volatility with an inability to execute trades, the foreign exchange market along with other markets needs a spark to bring some life back into the system or we will end up with quasi-fixed exchange rate system again.
  • Japan reported August national CPI and it came in as expected. The U.S. inflation rate is somewhere between 1.50% and 2.00% depending on which indices you use. Japan continues to be mired in sub-one-percent inflation despite all the QE and negative interest rates supplied by the Bank of Japan in hope of sparking life back into the economy and inflation. YoY inflation came in at 0.3% after July’s reading of 0.5%.
  • Canadian Retail Sales for July came in weaker than forecast at 0.4% following a 0.0% print in June. Canadian interest rates and the Canadian dollar are both weaker following the news. The Canadian national election is on October 21st and with recent revelations concerning PM Trudeau, Conservatives are close behind PM Trudeau’s Liberals creating some uncertainty about who lead the Canadian government.
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