World's Central Banks Just Can't Quit on Currency Intervention

(Bloomberg) -- History shows that central banks rarely stem a currency’s long-term decline simply by spending foreign-exchange reserves. Yet not stepping in at all can prove far worse.

That’s the argument used by authorities in Brazil, Indonesia and most recently Argentina to explain why it makes sense to shower billions of dollars on what looks like a losing bet. This week alone, Argentina spent about $3 billion, or 5 percent of its reserves, to bolster the peso after it plunged to a record low. Then, wielding another monetary cudgel, it unexpectedly goosed interest rates.

In Buenos Aires, the combination worked -- at least for today. The peso ended just a blip or two in the green after sliding 1.8 percent earlier. It’s still this year’s worst-performing major currency, nosing out Russia’s ruble and the Turkish lira.

“It was a success in the sense that it gave two signals to the market,” said Daniel Chodos, a strategist at Credit Suisse based in the Argentine capital. "One is that it can and will use all available instruments to conduct monetary policy, that is, interest-rate and FX interventions. The second signal is that because of the tool kit it has, it can intervene and cause some pain to markets.”

Indonesia is a more cautionary tale. The southeast Asian nation’s central bank drained $6 billion of foreign reserves in February and March partly to stabilize the rupiah, and may have further eroded the $126 billion pile as it stepped up intervention this month. But the moves, coupled with a threat to hike rates, didn’t calm volatility. That led the central bank to say it’s preparing a second line of defense to ensure liquidity.

Brazil’s interventions in the foreign-exchange market, using currency swaps, became so regular between 2013 and 2015 that traders started likening them to "ração diária," the moment each day set aside to feed your pets.

That didn’t reverse the depreciating real, given the nation’s deteriorating fiscal accounts and political turmoil that culminated with a presidential impeachment. Still, a research paper from the Atlanta Federal Reserve said the moves prevented the real from overshooting amid a tumultuous market. Over time, the program lost effectiveness as it failed to prevent the real from adjusting to new fundamentals, according to the Fed paper.

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