World Peace in the FX Hood?

There has been a lot of talk in the past few months about a brewing currency war. With the G20 summit scheduled to start tomorrow, rumor has it that the Bank of Japan (BOJ) could be placed in the hot seat again for how the yen has weakened drastically due to the central bank’s aggressive easing of monetary policy. After all, since the BOJ’s monetary policy statement back on April 4, USD/JPY has risen over 500 pips.

USD/JPY Chart

How likely is a currency war exactly?

Well, according to European Central Bank (ECB) President Mario Draghi, there’s really nothing to fear. Earlier this week, he showed support for Japan’s efforts to beat deflation by reaffirming the previous notion that Japanese policymakers aren’t really aiming to depreciate the yen.

In fact, Draghi said the BOJ’s decision to double its bond purchases and set a 2-year target for its goal of 2% inflation was “determined by domestic policy considerations” and that “there is no currency war.”

Some believe that Japan won’t receive flak at the meeting for its QE program since other major economies (such as the U.K. and U.S.) have been using similar programs. But apparently, not everyone shares the same sentiment as Mario Draghi. There has been a lot of talk about the U.S. having plans to say a thing or two about Japan’s recent moves.

Just last week, the U.S. Treasury Department issued its semi-annual currency report and declared that Japan must “remain oriented towards meeting respective domestic objectives using domestic instruments and to refrain from competitive devaluation and targeting its exchange rate for competitive purposes.”

In layman’s terms, what this means is that the U.S. is cool with Japan using aggressive easing, just as long as it’s used to combat deflation and boost its stagnant economy, and not to give its exports an edge in the global markets.

How the markets react to the G20 meeting will depend on how the world leaders will discuss the issue of a currency war. If currency manipulation and exchange rate issues become a hot topic at the meeting, it could lead to gains for the yen. On the other hand, if officials brush off talks of currency war or imply support for Japan, it could give markets the green light to keep dumping the yen.

What everyone seems to agree on is the need to support and boost global demand, as officials from all around the world are looking to work together to support the ailing world economy. Hopefully this meeting will be productive and yield actual results, and won’t just be another chance for the world’s bigwigs to share drinks and rub elbows.