This ChartBrief looks at the REER (Real Effective Exchange Rate – from the BIS) for China and Japan. You probably have two questions; why these two countries, and what are REERs? First is China has seen its REER down 7% so far this year, and Japan up 18% YTD. When you see this type of movement you begin to get interested (I do). The reason is on the charts they seem to look like a trend change on both counts.
As to the second question, what’s a REER? BIS says: “Nominal EERs are calculated as geometric weighted averages of bilateral exchange rates. Real EERs are the same weighted averages of bilateral exchange rates adjusted by relative consumer prices.” i.e. they are basically trade weighted currency indexes. As an analytical tool they can be used to assess whether a currency is looking stretched vs its longer term trend (for trending currencies) or vs its long term average (for mean reverting currencies). As they are trade-weighted they provide a useful cheat sheet as to whether a currency is moving in a way as to make that country’s exports more competitive (a lower REER) or less competitive (a higher REER). Also as to whether its inflation outcomes are being pushed up (by a weaker currency) or pushed down (by a stronger currency). Thus if the above chart does represent a trend change it would imply economic out-performance by China in terms of higher inflation outcomes and more competitive exports relative to Japan. Something to think about, and a trend to keep an eye on.