The Fed may have just stoked a 'currency war'

Are we on the cusp of a currency war?
Are we on the cusp of a currency war?

A lack of activity by the U.S. Federal Reserve on Thursday may not have been a surprise, but it's left no doubt in analysts' minds that other central banks will now look to ease policy further, a move that could send more shock waves across global currency markets.

Valentin Marinov, managing director and head of G10 FX research at Credit Agricole, told CNBC Friday that he expects global "currency wars" to intensify from here. He predicts the Bank of Japan (BOJ), the European Central Bank (ECB) and the People's Bank of China (PBOC) has now effectively been pushed into unveiling more stimulus.

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"The Fed inaction could spur other central banks into action," he said. "It is currency wars."

The dollar skidded to a three-week low against a basket of major currencies after Thursday's decision. This comes after the greenback had been appreciating significantly since the middle of last year in anticipation of higher interest rates in the U.S.

A higher interest rate can mean a higher yield on assets and investors in the U.S. have been busy bringing their dollars home, and thus out of high-yielding foreign investments.

A weaker dollar in the short term could now leave other global economies frustrated and dent export-focused companies that favor a weak domestic currency.

Manipulating reserve levels can be one way that a country's central bank can intervene against currency fluctuations. Other measures include altering benchmark interest rates and quantitative easing. Central banks often stress that exchange rates are not a primary policy goal and can be seen more as a positive by-product of monetary easing.

There have been discussions in the last few years that countries are purposefully debasing their own currencies -- a concern that was termed "currency wars" by Brazil's Finance Minister Guido Mantega in September 2010.

Credit Agricole's Marinov highlighted that the ECB could be the next to act by ramping up its current bond-buying program, thus weakening the single currency – even though its only mandate is to manage inflation.

Analysts at BNP Paribas also stated Friday that the Fed decision had increased their conviction that the ECB would increase its quantitative easing program. Marc Ostwald, strategist at ADM ISI, said in a note Friday that the ECB and the BoJ who will now face "even bigger challenges, given that the Fed is clearly not in any hurry to live up to its part of the 'policy divergence' grand bargain."

A trader on the floor of the New York Stock Exchange reacts to news that the Federal Reserve decided to not raise interest rates on September 17, 2015 in New York City.
Global markets unconvinced by Fed inaction

But there's also the volatility coming from China. Growth concerns in the world's second-largest economy have spiked in recent weeks after the country's central bank decided to intervene and weaken the renminbi. This managed to roil global stock markets with the Shanghai Composite seeing a rapid retracement of its year-to-date gains.

Chinese authorities might want a change to a more consumption-led economy, but this devaluation proved to many that they are not scared of helping out their export-focused sector. And Marinov highlighted that a weaker dollar could now mean China could devalue further as the country looks to deleverage its economy.

"(This) could unnerve and indeed lead to more market turmoil," he said.

"So by implication the Fed might be seeing more risks to their lift off," he said.