Third Anniversary
August 6, 2010
The world financial crisis began on August 8, 2007. The third anniversary finds a very heterogeneous world business cycle. Growth in global real GDP is again above 4.0%, something almost nobody foresaw a year ago. Many emerging economies in Latin America and Asia, a far wider spectrum than just India and China, are experiencing very dynamic activity again. Advanced industrial nations as a group are much more hung over than the more nimble emerging world, but it is in truth hard to generalize among that group because very uneven circumstances. Germany once again is out-competing the rest of Europe, and France has done very well, too. Canada and Australia look better than New Zealand. U.S., British and Japanese prospects seem to be fading, and parts of continental Europe remain quite depressed.
Such a muddled picture begs for simplification if possible. The table below of vital market signs on August 8, 2007 and its first, second, and third anniversaries provides one possible insight into the past three confusing years. Many of the variables underwent directional reversals, but not three of them.
- Ten-year sovereign debt yields fell consistently in the United States, Germany, and Japan. This is a sign of risk aversion, disinflation, and great uncertainty that sustained economic growth like that experienced before the crisis will return in our lifetime. Long-term interest rates are falling, not merely stable, in spite of an omnipresent fear about the implications of enormous government deficits and debt.
- All stock markets fell initially, but the Japanese Nikkei, unlike equities in Europe and the United States are weaker than a year ago. When the financial crisis began, the Nikkei was already 56.2% below its end-1989 historical high. It is now weaker by a further 43.4% than it was three years ago.
- After the onset of the crisis, the yen rose against the dollar by 9.0% in the first twelve months, 13.6% in the second twelve months, and 13.5% in the last three months. The forces of risk aversion are driving the yen steadily higher against the dollar, irrespective of Japan’s weak economic fundamentals like very low interest rates and sinking equity prices. In this instance, causation appears to be running from the currency to the economy, not the other way around.
| 8-8-07 | 8-8-08 | 8-8-09 | 8-6-10 | |
| EUR/USD | 1.3797 | 1.5081 | 1.4295 | 1.3275 |
| USD/JPY | 119.84 | 109.90 | 96.78 | 85.25 |
| Oil | $72.00 | $115.08 | $70.93 | $81.18 |
| 10Y, U.S. | 4.81% | 3.93% | 3.85% | 2.82% |
| 10Y, Germany | 4.41% | 4.26% | 3.51% | 2.51% |
| 10Y, Japan | 1.76% | 1.47% | 1.44% | 1.06% |
| Djia | 13,651 | 11,734 | 9,370 | 10,535 |
| Dax | 7,550 | 6,562 | 5,459 | 6,260 |
| Nikkei-225 | 17,029 | 13,330 | 10,412 | 9,642 |
Investors have become increasingly dubious that the yen and euro will keep advancing against the dollar over the remainder of 2010. First, let’s consider the yen, which set weekly highs of 89.27 in the week of June 25, 86.97 in the week of July 2, 87.97 in the week of July 9, 86.26 in the week of July 16, 86.35 in the week of July 23, 85.94 in the week of July 30 and 85.07 in the week of August 6. That’s a grind, not a rout, averaging 0.4% per week, and the trade-weighted yen has been even steadier because of appreciating trends in many other regional currencies like the Malaysian ringgit, Singapore dollar, Indonesian rupiah, and South Korean won. Nervousness that the yen will keep rising stems from the unit’s level, not its rate of climb. Today’s high of 85.02 per dollar was just 15 pips from last November’s peak of 84.83, a 15-year high. The yen has never been stronger than 79.85 per dollar, which it touched briefly on April 19, 1995, and its year-to-date average level of 90.61 per dollar is 3.8% stronger than its whole 1995 mean value. Officials are never comfortable when their currency wanders into territory that’s never been explored historically, but I wouldn’t count on such misgivings to rule the possibility. It does not look like risk aversion is disappearing.
Europe’s common currency has recovered against several currencies. It is up 12.3% against the dollar since June 7, 5.9% relative to the Swiss franc since July 1, and 3.4% against sterling since June 29. The dollar’s support from a higher Treasury than bund yield has been shaved. Since end-May, ten-year Treasuries have dropped 45 basis points, while their German counterparts fell merely five basis points. Reassuring results from stress tests on European banks and economic data trends favoring Euroland over the United States also lifted the euro. However, Europe faces much more forceful monetary and fiscal restraint than the United States, which many analysts think will send the euro back near its June lows by December. Just remember that when just about everybody is forecasting the same currency movement in the coming 4-6 months, it is often wrong. Moreover, many of the same market types are also predicting a collapse of U.S. stock prices. That’s not necessarily bad for the dollar, since it implies a return to ultra-risk aversion, but such gloom does underscore the high amount of uncertainty that surrounds future prospects.
Sterling’s rebound from $1.4347 on June 8 to as high as $1.6001 earlier today was not foreseen by many. When a new government takes a radical turn in fiscal policy, a potential always exists for a big move in the currency. The Kemp-Roth tax cuts after Reagan’s election in 1980 became a key piece of the foundation for the dollar’s renaissance but only because that policy was married to a very restrictive monetary policy and produced high real interest rates and a quantum decline of U.S. inflation. Around the same time French fiscal policy became very stimulative after Mitterrand was elected president in May 1981, and the French franc had to be devalued against other European currencies three times within 18 months. While these are disinflationary times, Britain is the one advanced economy where inflation has been repeatedly higher than forecast. Bank of England Governor King has accentuated the negative in recent comments about growth trends presumably to quell speculation about a British rate hike. The market does not seems quite convinced. It would be indeed plausible for the Bank of England to raise its Bank Rate before the ECB moves its refinancing rate or the Fed engineers a rise in short-term U.S. interest rates.
Historically, August has been a month when reversals in dollar direction occurred more frequently than during early autumn. Trading volume tends to be low and erratic, but the data flow takes no time off. There’s always something happening in the news. Next week will be no exception. That is the week each month when China releases many indicators. The FOMC holds its fifth policy meeting of 2010, and second-quarter real GDP will for the first time be reported by Euroland and several of its key members. The Bank of England’s quarterly Inflation Report and Japanese machinery orders get released.
Copyright Larry Greenberg 2010. All rights reserved. No secondary distribution without express permission.
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