Currency Markets Wrapping up Quarter One of 2010

March 26, 2010

First-quarterend 2010 coincides with the Easter and Passover holiday, a time of thinning volume.  1Q10 was a good period for the dollar and a bad one for the euro and sterling.  Dollar/yen marked time around the big figure of 90.0 as U.S.-Sino tensions over the yuan intensified.  After steep losses against commodity-sensitive currencies in 2009, the dollar was narrowly mixed against that group in the early going of 2010.  Within Europe, the Swiss franc advanced against the euro and pound but less than half as much as the dollar did.  In other financial markets, stocks experienced a very poor January, which can be a bad omen for the year, but turned higher thereafter.  Long-term interest rates traced a similar pattern, and some analysts attributed their rise in the second half of the quarter to concern over fiscal prospects.  Tensions in Europe over possible support for Greece festered during the quarter, unearthing old misgivings about the sustainability of a common regional currency and subjecting the euro to waves of selling pressure that intensified in March.  The summit of EU leaders at the end of this week saw them choose solidarity over all-out crisis, with an agreed significant role for the IMF in the resolution.  Beyond that, details remain vague regarding the amount, terms, and timing of aid to Greece, what the country must do in return, and how this agreement might be applied to other fiscally impaired economies in the region.  The Obama Administration avoided a technical knockout over healthcare but is clearly not out of the woods politically. 

Looking ahead to the spring quarter, I suspect the euro faces further softness, even though an interest rate increase by either the Fed or the ECB during 2010 looks doubtful.  The euro’s problems were not due solely to worries over the debts of Greece and other peripherals in the monetary union, or even to its lack of political cohesion and the possibility of eventual defections.   Euroland had unexpectedly suffered a considerably deeper drop of GDP than the United States in 2008-09, and its recovery likewise has been shakier and more narrowly based so far.  Real GDP rose just 0.5% at an annualized rate last quarter.  The strongest link then, France, has cooled recently.   Spain and Italy suffered GDP drops last quarter, and industrial orders in Euroland as a whole started this quarter with an unexpected decline of 2.0%.  Blame has been directed at the German economic policy game plan, which will seemingly subject the rest of the region to mounting impoverishment no matter what remedies are tried.  The euro had risen only 2.6% against the dollar in 2009, less than half as much as it has dropped this quarter, and over twenty months have now passed since it registered its strongest value against the U.S. currency.

From a Euroland policymaker’s standpoint, orderly depreciation of the euro is a development to be welcomed.  The region has considerable unused resources, which should lead to lessening core inflation.  From a U.S. perspective, continuing dollar strength is nothing to gloat about unless it can be offset with depreciation against Asian currencies.  Otherwise, net exports, which accounted for 1.1 percentage points (ppts) of positive economic growth in 2009 including 0.3 ppts in the final quarter, will be providing diminishing thrust, thereby stalling the needed rotation of economic growth away from domestic demand.  Western policymakers and currency market participants are losing patience waiting for the renminbi to resume an appreciating trend against the greenback.  It’s going to start this year but at an excessively gradual pace and not before the U.S. labels Beijing a currency manipulator.

China’s currency freeze constrains movement of some other Asian currencies, notably the yen which lost 2.5% on balance against the dollar in 2009 and showed a year-to-date uptick of merely 0.6% as of 15:00 GMT today.  April used to be good month for holding yen. In the 18 Aprils from 1989 to 2006, the yen fell 1.0% or more only three times and occasionally saw large-sized gains against the dollar such as one of 3.4% between end-March and end-April 2006.  In the past three years, however, yen movement during April has conformed better to the myth of weakness based on post-fiscal year redeployment of capital overseas.  Against the dollar, the yen fell 1.4% in April 2007, 4.0% in April 2008 and 0.2% in April 2009.

A lot of key economic data get released in next week’s holiday-shortened period.  We know that European purchasing managers indices will show service sector activity partaking in the recovery to a greater extent than before, but the U.S. and Japanese PMIs also probably improved.  Other figures to watch will be the U.S. employment report, which is being touted as a breakout month, German retail sales, Euroland economic sentiment, British consumer confidence and revised GDP, and Japanese industrial production, retail sales, labor statistics and, most importantly, Tankan quarterly survey of corporate conditions and expectations.  The dollar should do well at times like next week when the spotlight is on relative growth, because most currency holders believe that fast non-inflationary growth correlates closely with currency behavior. 

Comparisons of real GDP growth invariably favor the dollar.  In the eleven calendar years that the euro has existed, real GDP expanded 2.1% per annum in the United States.  Although such a pace was far beneath the U.S. norm of 3.5% per annum over the fifty years through 1998, the pace was well above those of 1.4% in Euroland and 0.6% per annum in Japan. If one instead examines the nine years from 2001 to 2009 because 1999 and 2000 were years of generally strong growth, gdp expanded by an average of  1.6% per year in the United States, 1.1% in Euroland and 0.5% in Japan.  The paradox is that between the end of 2000 and the end of last year, the dollar fell by 34.2% or 4.5% per annum against the euro and by 18.8% or 2.3% per annum relative to the yen.  Taking the euro’s birth at the end of 1998 as an alternative reference period, the dollar over the ensuing eleven years dropped by identical rates of 1.8% per annum against its two major rivals.  When markets obsess about GDP growth, the dollar gains some favor, but the predicted support fails to hold up over the long run.

Important legislative elections will be held in Britain during the second quarter, Japan during the third quarter and the United States in the final quarter of this year. Britain’s two major parties are offering vastly different near-term fiscal approaches.  The Labour Party’s budget presented this week withholds the heavy medicine for another year to ensure recovery takes hold, while the Tories intend to plunge right into the formidable task of chopping the deficit to manageable size.  By itself, the Great Recession justified a weaker pound because financial services constituted a larger share of GDP in the U.K. than other advanced economies.  Britain’s downturn started earlier and ended later than recessions in most other economies.  The Bank of England hasn’t given up on the possibility of more quantitative easing in the future.  If the Tories win, monetary policy will need to exert a counter-weight against the drag of fiscal restraint, and sterling depreciation will be an element of that.  If no party secures a majority, markets will think back to the hung parliament in the 1970s during which sterling performed horribly.  And if somehow Labour Prime Minister Brown holds onto his job, one should bear in mind that under his guidance since he took the reins of power on June 27, 2007, sterling has dropped by 25.6% against the dollar, 25.2% against the euro and 26.2% on a trade-weighted basis.

The Bank of England, Bank of Japan, European Central Bank and Federal Reserve are not going to raise their benchmark interest rates in 2010, but central banks will do so unquestionably in Australia and Canada and probably in New Zealand.  Even though the dollar has held its own against commodity currencies in 1Q10, I like the loonie’s chances of strengthening beyond par by mid-summer and think the Aussie dollar will climb to at least $0.9500 some time this year.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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2 Responses to “Currency Markets Wrapping up Quarter One of 2010”

  1. Jimbo says:

    You should use your vast knowledge of financial history and do an article on similarities in our government policy and its consequences – comparing the present to the great depression.

    Are we coming out of the recession, or forgetting history and repeating it?

  2. larrygreenberg says:

    Your question is a good one, but the research required for a thorough answer would be very time consuming. To post as many articles as I do means constraining them to projects that can be done in minutes or a couple of hours. Let me instead offer a few quick thoughts off the top of my head. People interested in this subject are likely to find “Lords of Finance” by Liaquat Ahamed an excellent resource. This entertaining as well as informative book, which I unfortunately loaned to friend, examines the 1914-1941 period in detail from the perspectives of the Federal Reserve, Bank of England, Bank of France and German Reichsmark. Two deja vu moments come to mind. Germany’s punishing treatment of Greece and other PIIGS, as you’ve called them, is reminiscent of the reparations imposed by the WWI victors on Germany and by U.S. creditors on Britain and France. The obsession of the tea party folks with reducing government deficits mirrors similar calls by fiscal conservatives in the early 1930s, with very dire consequences. Roosevelt in 1937 later erred too in tightening fiscal policy too sharply when the economy wasn’t able to handle that. Separately, the defenders of “states rights” in the healthcare and other U.S. policy debates is a very old and toxic theme throughout post-revolutionary U.S. history. Such calls have often been strongest in the deep south. Much of what’s heard lately, like the effort by attorney generals in Florida and other states to void the healthcare bill with a Supreme Court challenge is essentially a variation on the “nullification doctrine” — see http://encyclopedia2.thefreedictionary.com/Doctrine+of+Nullification . Sharp regional differences, which became extremely strained over slavery, tariffs, and other taxes in the nineteenth century, are very much alive in the 21st century.

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