The Federal Reserve may increase interest rates and lift their terminal rate to a higher level. Japan and the U.K. are already in a currency crisis. Could Australia be next? As a divergence between dovish Central Banks and a hawkish Fed, may set off a wave of Foreign Exchange inflation.

Chart 1

Chart 2

As the Australian Dollar (AUD), Japanese YEN and Pound Sterling (U.K.) begin to diverge from the U.S. Dollar, with the YEN and Pound already in a currency crisis as their Central Banks begin to offer dovish rhetoric to the mix, which is offering to the market that a pause is on the way in their interest rate cycles, at a time when inflation is still persistently imbedded within the global economy.

Refer to Chart 1, which shows the collapse in the YEN, the once safe haven currency, the Pound and AUD all falling over 1% at the start of March 2023, after rising over 1% when the market incorrectly priced in a pause in interest hikes by the Federal Reserve.  All the while the America service sector, wages and energy costs are still pushing prices upwards.   With the Fed  looking at a larger rate hike at their next meeting/decision on late March 22nd, which could be at 0.50%.  

The Pound Sterling is in a similar state to the YEN, although not a safe haven, it is what was once considered a stable currency of Europe is now sitting close to 30+ year lows against the U.S. Dollar.   Although the Bank of England has committed to rates hikes as opposed to Bank of Japan's manipulation of the yield curve and currency intervention to raise the YEN, the BoE offered to the market a 4% rate rise.  Please refer to Chart 2, showing interest rates (Orange line), Pound (white line) and inflation (red line).   Yet, inflation in the U.K. is still at 20 year highs at 10.1%.  To tame inflation, the BoE may need to move their terminal rate to their late 1990's percentage at over 7%.  Can they do it?   The hope is that inflation will start to fall rapidly, which is rather delusional.  Hence Fed chairman Jerome Powell advising, via his testimony (7th March 2023), that inflation is persistent and a higher terminal rate for the Fed maybe warranted.  

Refer to Chart 1 again, which showed the massive sell off of the AUD (bar chart), after Powell's comments about the need for larger rate hikes and a higher terminal rate, the AUD fell from 0.67 to 0.65.

If we are to have a continued divergence between dovish Central Banks such as the BoJ, BoE, Reserve Bank of Australia and hawkish Federal Reserve, countries like Japan, U.K., and Australia will begin to import inflation if their currencies continue to be sold off.  This currency inflation will add to the of already higher cost of living and business expenditures.