BNY Mellon: Further Thoughts on the Seeming Calm

February 22, 2019

While parts of the currency market may appear calm, all is not what it appears.

The second half of the 1960s witnessed a sizable increase in domestic and military spending by the US government that finally led to a breakdown of the Bretton Woods system that had seen the price of gold pegged at USD 35 an ounce. The key moment was the Nixon Shock of 1971 when the president “closed the gold window”.

Although the price of gold stabilized between 1975 and 1976, easy monetary policy settings during the remainder of the decade - along with European currency turmoil - saw it resume its climb.

By the election of President Reagan in 1980, gold (in CHF terms) was worth over five times what it had been at the time of the Nixon Shock. Against the JPY it had increased in price nearly eightfold, while against both the USD and GBP it was worth over thirteen times what it had been.

Demand for gold moderated in the aftermath of the 1980 election thanks to the president’s promise of a drastic cut in "big government" and a pledge to deliver a balanced budget. Significant support for this stabilization of the system also came from the Fed thanks to a renewed focus on dealing with inflation.

This period of stability came to an end in 2001 when the BOJ decided to set the level of its current account as the operating target. In practical terms, the policy required the BOJ to purchase a range of financial securities in order to flood the financial system with excess liquidity.

The initial size of the operations did little for sentiment. However, a tipping point was reached in December 2001 when the bank said that it would increase its operations for the second time.

This marked the point that the reemerging uptrend for gold began to gain momentum.

After a setback during the global financial crisis, the introduction of QE programs by the FOMC and others supercharged the subsequent rally, taking gold from below USD 700 per oz to over USD 1,900 per oz in just under three years. 

Gold began sliding lower in October 2012. However, the major decline emerged after April 10, 2013 as it became clear that the Fed was preparing to taper its asset purchases.

By the end of that week, gold had fallen 6.7% against the USD while by the end of June it was down by almost a quarter. While prices did trend lower overall from then until the end of 2015, the lion’s share of the move had already taken place.

The downtrend drew to a close when the FOMC adopted a more cautious stance in the face of CNY-related market turbulence in early 2016.

Unsurprisingly, a fresh rally in gold prices against all the major currencies has been building since the Fed "put" reemerged in November of last year (see chart above).

This rally has only intensified in recent weeks as the Fed has signaled it is looking to bring its asset reduction program to a close and both the BOJ and ECB have sounded more cautious.

The point is a simple one: the calm that seems to have enveloped parts of the FX markets of late isn’t really calm at all. Instead, many of the major currencies are simply falling in value at roughly the same pace.