A straw poll of a couple of big foreign exchange market participants found that about one-third of them believe there will soon be concerted central bank intervention to support the dollar. And the majority of them believe the chances will increase if there is a disorderly move in euro/dollar above 1.6000.
Perhaps those who believe there will be action have read a recent note from BNP Paribas, which the bank itself cautions is not objective research, but which is an interesting read nevertheless. The bank points out, perhaps to the disbelief of many younger traders who have never witnessed the chaos that intervention to dampen volatility can create, that concerted action can work.
Many believe that intervention does not occur these days because the market has grown far too big for it to work. The market is far larger than the periods between 1986 to 1988 and 1992 to 1996 when intervention almost became the norm. According to a research note published by the Bank for International Settlements in Basle (BIS Papers No 10, Central bank intervention and market expectations, Gabriele Galati and Will Melick, April 2002), the central banks intervened in dollar/Deutschmark on 87 days in the period 1986 to 1988. "During this period central banks intervened by leaning against the wind: they purchased dollars during times when it was on a declining trend and sold dollars when it was strengthening. On average, following intervention these trends moderated in dollar/Deutschmark," the authors write.
A few years later, and the central bankers felt they had to take action again. BIS points out that they intervened on 154 days between August 1992 and December 1996 buying dollar/yen. They also waded in on 11 days to buy dollar/Deutschmark.
"I think we will see concerted intervention if we hold at all above 1.60," says a veteran senior trader. "Remember that the hedge funds do not have the teeth or the appetite that they once had to take on the central banks. Intervention would be most entertaining. ‘What, no price on EBS? Oh what am I to do?’"
The market’s depth ultimately might not be that relevant. An old report from 1993 (Does foreign exchange intervention work? Institute for International Economics, Washington DC, K Dominguez and J Frankel) likened intervention to the successful cattle-herding tactics of dogs. Even though they are smaller in size and fewer in numbers, the dogs can make a herd change direction by causing a stampede because the cows are scared into following their neighbours.
BNP Paribas seems to agree with such sentiments, making a fuller argument of why the time might be approaching for action to support the dollar. "Over the years there has been extensive research investigating the effectiveness of central bank intervention. Examination of this research together with our own studies allows us to draw the conclusion that under certain conditions co-ordinated FX market intervention can be successful," it writes.
The bank says it believes that "the conditions for successful coordinated intervention in support of the dollar are now only just starting to fall into place. These conditions include consistent global monetary policy, extreme currency valuations and a turn in the market trend. Also, sentiment among the G8 and other global monetary authorities appears to be changing with regards to the dollar and there is now an increasing interest globally in a stronger dollar."
It adds: "It is interesting to note that at the early July G8 meeting the European officials were becoming increasingly vocal about the level of the euro, including French president Nicolas Sarkozy and the German chancellor Angela Merkel. US Treasury secretary Henry Paulson’s recent visit to the Middle East has also increased speculation regarding supportive action for the dollar."
BNP Paribas says market participants should at least be prepared for intervention. "With the conditions for dollar supportive intervention starting to fall into place as well as the political willingness globally to act, we believe that investors should be prepared for the possibility of co-ordinated action."
The bank points out that its purchasing-power-parity measure suggests that the fair value of euro/dollar is 1.2364. At its current level of around 1.5800, it is at its most undervalued reading for more than 30 years. "In fact, the current level of overvaluation of euro/dollar is similar to the level of undervaluation witnessed during the last G7 coordinated intervention action to support the euro in 2000," it points out.
But for the moment, the majority of FX participants believe that there will not be any concerted action. "I would guess, given the amount of dollar reserves held by foreign central banks coupled with their desire to reduce their holdings, that any dollar rally would be short-lived. The world is a different place from the days of the Plaza Accord. They will only intervene if there is complete chaos, such as a 10% move in day," is one trader’s view.
"The US Treasury does not believe that the dollar is the cause of the problem. Rather they see it as being weak because of commodity price inflation and financial stress," comments another doubter.