Weekly Foreign Exchange Insights: September 11th

September 11, 2009

Dollar weakness has carried over into the autumn trading season as investors assumed it would.  The dollar has so far lost 1.9% or more against the euro, Swiss franc, sterling, kiwi, and yen in the week of September 11th.  From 2009 highs, dollar depreciation exceeds 25% against the Australian and New Zealand dollars, surpasses 15% against sterling and the Canadian dollar, is roughly 15% against the euro, and lies between 10% and 14% relative to the yen and Swiss franc.

In a world of low interest rates, U.S. levels are among the lowest, and so the dollar has taken on the aura of a carry trade liability currency.  One-month rates are lower in the United States than Euroland.  The three-month euribor rate exceeds its U.S. counterpart, and two-year German bunds offer a 33-basis point premium on Treasuries of the same maturity.  For 10-year notes, Treasuries and bunds have similar yields, and they are both slightly more than 30 basis points below 10-year British gilts.  A carry trade image on a currency that offers few prospects of appreciation on other considerations is an open target for speculators.  Moreover,

  • The dollar tends to be softer in the autumn season than other times of the year.
  • September is the final month of Japan’s fiscal first half and a month when Japanese corporations have accounting incentives to repatriate funds home.
  • The Obama administration is fighting many wars but conspicuously silent about dollar depreciation, which it may welcome as long as such stays orderly.
  • Foreign officials in China and elsewhere have not protested dollar weakness lately as loudly as they did a few months ago.
  • The U.S. trade deficit recorded the largest monthly increase in July since 2006 and may produce more negative surprises to mitigate GDP recovery.
  • Gold has climbed above $1000 to record highs.  While partly a symptom of eroded confidence in the dollar, the attainment of such a milestone draws attention to the dollar’s vulnerability and may thereby promote further diversification away from the U.S. currency.

Former President Ronald Reagan famously asked Americans in 1980 if they were better off than four years earlier.  The same question can be asked today, only an interval of eight years seems most appropriate because September 11, 2001 is one of the most infamous days in U.S. history.  War subjects domestic economic activity to significant shock, sometimes favorable as in World War 2 but more often negative.  U.S. GDP over the past eight years averaged 1.6% per annum, down from 3.7% per annum in the prior eight years, and U.S. jobs actually slid on balance by 0.1% per annum compared to an increase during the previous eight years of 2.2% per annum.  The Dow Jones Industrial Average at this very moment just prior to noon in New York is 9606, exactly matching its close on September 10, 2001.  The Dax, by comparison, is 20.4% higher than then.  The U.S. current account deficit amounted to $406.0 billion at an annual rate in the first quarter of this year, also very similar to the full-2001 shortfall of $398.3 billion.

Not directly but indirectly through the changes that the 9/11 attacks imposed on life in American, public policies, the civility of U.S. politics, and the confidence of observers around the world that the United States can solve whatever problems might arise, the 9/11 attacks dealt a sustaining blow to the dollar.  Markets weren’t talking in 2001 as they do now about the dollar sharing reserve asset hegemony or stepping aside for a new international currency in a redesigned monetary system.  Over the eight years between September 11, 1993 and 09/11/01, the dollar had risen at annualized rates of 3.9% against the mark, 3.0% against the Australian dollar, 2.3% against the Swiss franc, 2.2% against the Canadian dollar, 1.7% against the yen, and 0.7% against sterling.  Nobody knew it then, but the dollar’s second post-1973 golden age was about to end.  Since the attacks, the dollar has depreciated at annualized rates of 5.9% against the euro and Swiss franc, 6.3% against the Australian dollar, 5.5% against the Canadian dollar, 3.6% against the yen, and 1.7% against sterling.  Al Qaeda’s intent eight years ago was to undermine America’s economic strength, cultural influence, and military influence in the middle east and other parts of the world.  I can think of no better way to promote that mission than by lighting a fuse to explode away the dollar’s lynchpin position in the international monetary system.

In coming days, traders will be watching some key currency levels.  Foremost, Japan’s currency has climbed within a half-yen of 90/$ and gets a new government at mid-week.  The risk of intervention, perhaps undertaken covertly, looms to halt the move at 90 and prevent a disorderly rapid travel through the 80s.  The Canadian dollar and especially the Swiss franc are now within hailing distance of par to the dollar.  The Bank of Canada’s statement yesterday warned of adverse consequences if the currency is excessively strong but took no action to influence the exchange rate.  Canada now faces political uncertainty that could topple soon the Conservative government and slow down the loonie’s rise.  The Swiss National Bank holds a quarterly monetary policy meeting on Thursday.  The 0.25% key interest rate target will be left alone, but a press conference comment about currency market conditions is very probable.  Swiss officials already have subordinated domestic credit policy to the goal of preventing the franc from appreciating through 1.50 per euro.  That cross rate is far more important to them than how much closer the franc inches toward 1.0000 against the dollar.  Other commodity currencies like the kiwi, Aussie dollar, and rand have advanced more rapidly than fundamentals collectively seem to justify, in part from hopes that interest rates in those countries will rise sooner and initially faster than G-7 policy rates.  Reversing the rise of commodity-sensitive currencies, however, probably needs the dollar to reverse ground in a more general way.

The most plausible scenario for a broad dollar upturn would be a marked relapse in the nascent global recovery and big equity market retrenchments.  Nobody wants to go there, even if it helped restore the dollar’s image temporarily.  Besides, that script seems unlikely over the balance of this year because of the momentum shown by developing economies and the positive inventory cycle that will exaggerate the improvement in G-7 growth.

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

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