Weekly Foreign Exchange Insights: October 31st

October 31, 2008

Currency and equity markets were strongly correlated in October, each moving to the ebb and flow of risk aversion. There was a massive unwinding of yen carry trades during the month as risk aversion fell to nil but not so much during the final week of the month as money markets thawed somewhat. When risk aversion subsided, so did equities, the euro, sterling, currencies that are sensitive to commodity prices and emerging market currencies. The dollar, like the yen, is now a low-yielding currency and thus moved directionally in tandem with the yen but with less amplitude against other currencies. The table below, based on quotes today at 15:40 GMT, shows selected moves in the dollar and in a number of equity indices during the past week and during the whole month of October. The figures do not represent a path of causation, running either from stocks to currencies or currencies to stocks. Equities and currencies each responded to the waxing and waning of risk aversion. Volatility was extreme in the final week of counter-trend movement as it had been earlier in October.

Dollar Against Month of October Week to 10/31
Yen -6.9% +5.0%
Euro +10.7% -0.8%
Sterling +9.8% -1.7%
Swiss franc +3.5% -0.4%
Canadian Dollar +13.8% -5.1%
Aussie Dollar +19.8% -5.9%
N.Z. Dollar +14.4% -4.8%
Hungarian forint +17.8% -9.0%
Ukraine hryvnia +27.7% +9.1%
Korean won +7.6% -9.6%
South African rand +20.1% -14.2%
Icelandic krona +20.8% -0.2%
Stocks:    
DJIA -14.8% +10.4%
Nikkei -23.8% +12.2%
Dax -13.0% +17.3%
Ftse -9.8% +11.9%
Canadian TSE-300 -13.9% +17.1%

 

Global money markets have become less acutely distressed, but economic prospects have darkened considerably. Japan reported a factory sector purchasing managers index today of 42.2 for October, down from 44.3 in September and 47.0 in June. Export orders sank 2.5 points to 34.5, and export orders fell to a record low. U.S., British and revised Euroland PMI data out next Monday and their service-sector counterparts on Wednesday will likewise document much weaker growth in the fourth quarter than the third quarter. Next week will also see the arrival of U.S. monthly labor statistics, British industrial production, and German industrial output, orders and exports. All of such will be weak, some frighteningly so. Although the Fed got the early jump on other central banks, it remains unclear that the U.S. recession will be any less severe or shorter than recessions in other world regions. What investors do know is that interest rates are now going to fall much more sharply in Europe than in the United States. This process begins next Thursday, when the Bank of England and ECB will each cut rates by at least 50 basis points and possibly more. Each central bank will also use that opportunity to confirm that more rate cuts are on the way and to convey a shift in risk priorities away from a feared acceleration of inflation.

This potential dollar-boosting knowledge did not prevent the greenback from relinquishing a chunk of its October rise in the final week. The sharp movements that continue to be experienced by the dollar and in the cross rates between non-dollar currencies is not the result of premeditated investor speculation of the sort that forced sterling to leave the European joint float in September 1992. These are liquidating markets. Assets have been sold often under duress in order to raise needed cash to cover losses or because of feared additional capital losses. The financial year for many hedge funds ended in October. Maybe that will usher in a little less volatility, but seeing will be believing in that regard.

Governments are likely to feel conflicted about currency changes. The euro is much more competitive than it was but not as soft as many politicians hope it becomes. No enthusiasm exists in Europe to join Japan in concerted intervention to cap yen strength. Tokyo will have to play that role alone, but unilateral intervention in theory should be just as effective as coordinated operations when the object is to debase, not rescue, one’s own money. I don’t think Japanese officials will be satisfied unless the yen moves back above 100/$. Not only would Japanese stocks and exports be jeopardized if the yen remains strong, but also deflation will become a mounting threat. From the U.S. perspective, the much better-than-expected performance of the dollar has been one of the few bright economic spots of 2008, as such has silenced predictions that other governments are poised to abandon the dollar as the most favored reserve currency asset. That risk should lie in abeyance for now, and the dollar’s managers at Treasury probably would prefer a period of greater forex market calm and reduced volatility. Nursing global financial markets back to health, a prerequisite for preventing a severe recession like those in the 1980’s and 1970’s from being something worse, will not be easy if currencies are swinging all over the map. It is somewhat surprising that policymakers have become much more interventionist in many areas but not in currency management, where the term for government interference is “intervention.”

America’s marathon election campaign will finally end… maybe. From the first election of Ronald Reagan i
n 1980, the dollar had not depreciated against both the yen and mark (now euro) between Election Day and Inauguration Day on January 20th until George W. Bush’s reelection in 2004
. But in that period in 2004/5, the dollar lost 2.0% against the euro and 2.3% against the yen. In 2000, the dollar slumped 8.0% against the euro but rose 7.5% versus the yen during the transitional period. After each of the four previous elections, the dollar rose against both the D-mark and yen, with average gains of 5.1% against the mark and 2.8% relative to the yen. The 1980 election will be remembered among other things for the Fed doing matched sales immediately afterward, which set the tone for the dollar to rally 4.3% in the transitional period on route to a 34% climb between Election Day and August 10, 1981. The dollar, however, fell 4.7% against the yen during the presidential transition period that transferred power from Jimmy Carter to Ronald Reagan.

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