Currency turmoil casts doubt on forex pegs

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Market turmoil often radiates from currencies and showdowns between central banks and aggressive investors.

A burning question early in 2016 is how long countries such as China, Saudi Arabia and others can continue to rely on currency reserves to spare their currencies from a pronounced drop in value. As the global economy shows further signs of weakening and the collapse in commodity prices has punctured the budgets of many countries, investors are betting on much weaker currencies and the end of the Saudi peg to the dollar.

Analysts are divided on whether traders or central banks will eventually triumph, but countries are burning through their reserves to hold the FX status quo, a strategy the likes of Bill Ackman and other hedge funds think cannot continue indefinitely.

There are two main purposes for putting FX reserves to use. Countries build up reserves for that rainy day crisis, to deal with “a Lehman event”, says Nomura’s FX strategist Charles St Arnaud — “to improve flow and make sure there’s liquidity in the market”.
FX reserves

The other is to close the gap between a country’s economic fundamentals and the position of its currency. “It depends what you’re trying to fight,” says Mr St Arnaud. “There has been a decent amount of use of FX reserves by central banks, but it’s hard to steer fundamentals.”

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