Weekly Foreign Exchange Insights: April 24th

April 24, 2009

Currency market momentum continues to revolve around risk aversion.  To remain well-bid, the dollar needs risk averse investors more than it needs evidence that the United States is coming out of the global recession sooner and more quickly than other regions.  When all is said and done, business cycles are likely to be more closely synchronized than anticipated on the way out of recession just as they moved in surprising tandem during it.  The primary factor behind surprising dollar strength over the past year was the premium investors put on securing a return of their money, rather than a return on their wealth. 

Equities remain a ready gauge for the ebb and flow in risk aversion.  And the key to equities seems to rest with the performance of financial shares.  Their outlook remains highly uncertain.  The publication of stress test results on May 4th will be critical, but leaks of those figures, both genuine and fake, are likely to surface next week.  Pranksters will be more likely to spread rumors accentuating the insolvency of banks.  Regardless of what the U.S. government chooses to report, many respected economists and market analysts will continue to suspect sugar-coating and hold the view than anything short of widespread nationalization is doomed to fail in the mission of restoring a trustworthy and functional financial system.  A near-term rout of the dollar seems unlikely because of such lingering concerns.

Nevertheless, the dollar has been looking more fragile.  President Obama’s domestic economic agenda has been labeled radical.  Investors are much more convinced that the deficit will soar above 10% of GDP in the near term than that in the president’s promise to rein it back in. Fiscal policy is more stimulative than in the early 1980’s and lacks the counter-weight of a tight monetary policy that promoted dollar appreciation then.  On the contrary, just as much nervousness is associated with a Fed exit strategy as surrounds medium-term fiscal prospects.  Now that European data, like U.S. data, suggest a less rapid decline of economic activity, the dollar is unlikely to test earlier 2009 highs without a significant new spike in risk aversion.  Significantly, the dollar at 15:00 GMT today was showing sizable weekly losses against all its traditional hard-currency rivals.  The greenback had dropped 2.3% against the Swiss franc, 1.8% against the yen, and 1.6% relative to the euro since the close on Friday, April 17th.

The loss against the yen in a week characterized by contained risk aversion deviates from recent patterns.  Because the yen financed carry trades, it had tended to be buoyed by bursts of risk aversion to an even greater extent than the dollar and had conversely been vulnerable whenever risk aversion waned.  Two possible reasons why this connection isn’t happening now may be that most carry trades are now unwound and the fact that dollar/yen seldom rises much in April. In any case, the yen remains 4% below the mid-point of its first-quarter trading range against the dollar.

Sterling has been the weakest major currency since the onset of the financial crisis in the summer of 2007. It has dropped some 26% since then against its trade-weighted index.  By comparison, the yen on such a basis has soared 32%, and the trade-weighted euro and dollar rose roughly by 6% and 7.5%.  Currency markets tend to overshoot, so the pound’s substantial drop thus far is no guarantee against further near-term depreciation.  Many depressants remain in place, such as runaway deficit spending, a combined budget and external deficit that surpasses 14% of GDP, substantial quantitative credit easing, annualized GDP contraction of some 6.6% over the last two quarters and 4.1% during the past year, soaring unemployment, mounting social discontent, and an unpopular government against which to vent.  All things considered, sterling earned a small victory by depreciating less than 1% against the dollar this past week.

The message from Swiss National Bank officials became less clear this week.  Their desires to forestall franc appreciation beyond 1.50 per Euro and to avoid excessive money growth could prove incompatible.  A test of that level looks more likely now than a week ago.  A pro-active currency policy oriented around promotion a direction tends to endure better than a strategy of defending a specific level.

Commodity-sensitive currencies remain very volatile.  High-low ranges in the first quarter exceeded 23% for the New Zealand kiwi and 16% in the Ozzie dollar’s case.  The ranges so far in April amount to some 9% in the kiwi’s case, nearly 7% for Australia’s dollar, and over 6.1% for the Canadian dollar.  The resilience of oil, up some 50% since February lows, in the face of the worst global growth in some 60 years is attracting increasing disbelief.  Gold is also looking pricier, but neither the Australian dollar nor the Australian currency have reacted sharply yet to this or to improved Chinese growth prospects.

The week ahead has several holidays: Australia is closed on Monday, Japan on Wednesday, and much of Asia, Europe, and Latin America on Friday.  Often, holiday interruptions translate into periods of mindless marking time.  But next week’s calendar is also loaded with central bank policy meetings including at the Fed and Bank of Japan, plus several key economic indicators will be released, including U.S. GDP, Japanese industrial production, and the Chinese and British PMI reports.  With gatherings today of the G7 and G20 kicking off the IMF meetings, the marketplace should probably be pretty lively.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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