Chart of the Day – Central banks helpless?

by Enis May 23, 2012 7:19 am • Commentary

What does it mean when global central banks are losing in the battle of their currencies?  Currency markets globally are showing incredible price action over the last week.  Price action that defies the moves of central banks.  Repeatedly.  For those of you only watching stocks, read my post here on why currencies matter and offer many clues for stock and option traders.

Today’s chart focuses on the recent price action in the Brazilian real.  First, some background: the Brazilian central bank routinely intervenes in the currency markets to manage its currency.  For the first half of 2011, it bought dollars and sold real to try and keep the real from strengthening (and thus hurt its exporters).  The exchange rate’s low was 1.5290 (1 dollar bought 1.5290 real).  But when global markets fell in the second half of 2011, the exchange rate moved almost 30%, almost above 2.00, and the central bank sold some of its dollars and bought real to calm the market.

More recently, the dollar has moved steadily higher against the real, breaching the 2.00 level in the exchange rate that it had not seen since 2009.  5 year chart:

Given the fast nature of this move and in an attempt to contain the panic, the Brazilian central bank  intervened on Friday around 2.06 in the exchange rate, selling dollars and buying real in an attempt to move the rate lower.  Surprisingly, the exchange rate got back to the 2.06 level by yesterday morning, when the central bank intervened again.  More surprisingly, the exchange rate this time spent only a few hours below 2.06 before blowing above that level in the last hour of yesterday’s trading.  Here’s the 5 day chart with the 2 interventions circled in red:

I mentioned this in the Quick Hits chat room yesterday afternoon as a very negative sign for risky trades.  When a central bank is having trouble containing U.S. dollar strength, it shows just how hungry investors are for U.S. dollars, the global safe haven.  The Indian central bank has lost the battle recently too, as the Indian rupee is now at an all-time low vs. the U.S. dollar despite multiple interventions.

It’s nerve-wracking price action that has not occurred since the financial crisis in 2008, and it’s one of the main reasons for the continued risk-off bias in my trading.  For a quick ETF indicator, continue to watch the performance of the WisdomTree Dreyfus Emerging Currency ETF, CEW.