Morgan Stanley has an interesting model that attempts to gauge the likelihood of currency intervention by the G3 economies (United States, Europe, and Japan). While there hasn’t been coordinated currency intervention since 2000, the potential for a repeat is rising due euro volatility, which appears excessive.
Morgan Stanley’s Sophia Drossos:
Based on our estimates, the model currently predicts a 30% probability of coordinated currency intervention compared with the long-term average of 12% (Exhibit 1). According to our framework, probabilities below 20% are consistent with a low level of intervention risk, probabilities between 20% to 30% are considered a signal of caution, while probabilities above 30% suggest a high risk of FX intervention.
Still, Morgan Stanley believes the euro remains over-valued against the dollar, thus mitigating other factors, such as the excessive momentum shown above which argue for coordinated currency market intervention from the G3.
Thus it could take more currency volatility than in the past to push to G3 into action, because from the look of the model above, probabilities are historically high yet we haven’t seen any intervention. (We’d also suggest the hypothesis that perhaps the model needs a tweak!)
Yet for traders, just be aware that government intervention is a growing risk.
(Via Morgan Stanley, G3: High threshold for FX Intervention even as risks rise, 20 May 2010)