Ride the Roller Coaster at Your Own Risk
October 1, 2010
The roller coaster metaphor describes currency market conditions since late spring very aptly. The ride starts and ends about the same place. But in between, one travels all over the place at dizzying speed, absorbing thrills and chills and winding up queasy for the effort. The ride is mindless fun and doesn’t enhance the public good. Nothing is built, and little remains at the end of the day. Take too many rides, and one might even suffer some brain dysfunction.
Euro/yen is one of many key currency pairs behaving like a roller coaster. From 114.16 yen per euro on June 3, the yen rose 6.4% to 107.33 on June 29. Then the euro fought back, advancing 6.4% to 114.19 on August 2. It was the yen’s turn after that to climb 8.3% to 105.44, but the euro has had the last laugh, advancing 8.3% to 114.22 yesterday, a mere 0.1% above where the ride began four months ago. Along the way, 33% of two-way highway was traveled, an annualized 134% rate of two-way foreign exchange rate movement. Catch those turns correctly, and one can get rich in a hurry in a game with very few barriers to entry. The profession carries enormous risks, however, to balance the potential for big rewards. With well-paying jobs in many other sectors very hard to land, the temptation is great to give the forex roller coaster a whirl despite its intrinsic dangers.
And what about the economies of Japan and Euroland, which represent the public good? If one only looks at the start and finish, things seem great. No cumulative movement has occurred, an epitome of stability when both regions are desperately trying to maintain recovery paths and relying heavily upon healthy net exports to sustain economic growth, as the United States and China are also doing. But the ride, as mentioned, has been dizzying and not at all the predictable anchor that businesses need for planning and educated risk-taking. If 114.2 euro per dollar is just as appropriate in clearing market supply and demand in early October as it was four months earlier, all that volatility is regrettable in a world economy that is convalescing from an enormous shock to its system and still trying to find ways to reduce imbalances between savings and investment.
The EUR/JPY has not been exceptional object of volatility. There have been other examples see-sawing price action.
- The euro rose from $1.1878 on June 7 to $1.3333 on August 6, fell to $1.2587 on August 24, and climbed back to $1.3780 today.
- The Canadian dollar retreated from 1.0107 per USD on August 5 to 1.0672 on August 31 and returned to 1.0192 yesterday.
- The Australian dollar ricocheted between USD 0.8068 in late May, USD 0.9221 in early August, USD 0.8772 three weeks later, and USD 09752 today.
- The dollar rose 4.4% against sterling to $1.5329 on August 31 from $1.6002 on August 31 but was back at $1.5922 on the final day of September.
- Against the kiwi, the dollar advanced 6% to 0.6949 between August 4 and 25th, but New Zealand’s currency followed that drop with a 7.4% advance.
In the midst of summer’s see-sawing volatility, a sense of likely future dollar directionality has in fact sharpened into clearer focus. The final week of the third calendar quarter grasped this gestalt. The U.S. currency fell broadly this past week, and as of 15:00 GMT today it had dropped by 1.9% against the euro, 1.2% against the Aussie dollar, 1.1% relative to the yen and kiwi, and 0.9% against the Swiss franc. The Fed has taken the unusual step for any central bank of announcing that inflation needs to rise over the short- to medium-term. That goal is backed by maintaining a conditional prediction that its interest rates will remain at exceptionally low levels for an extended period. What’s surprising about such a statement is that the Federal funds rate has already been targeted in a range of zero to 1/4 percent since December 2008. And if such low rates are not sufficient to boost inflation, new quantitative easing to increase the supply of dollar liquidity will be undertaken. The Fed hasn’t explicitly said it seeks a weaker dollar, but such a development would act to boost import prices and support its overall inflation objective.
The Obama administration has not explicitly advocated general dollar depreciation, either. And yet in an indirect way, the green light to sell the dollar has been switched on by the White House. In last January’s State of the Union address, President Obama announced,
So tonight, we set a new goal: We will double our exports over the next five years, an increase that will support two million jobs in America.
Investors are right to suspect Washington of pursuing a dollar policy of benign neglect. It would surely not be the first time such a strategy was pursued, and present fundamental economic parameters make this a ripe time to do it again. Deflation, not inflation, is the greater price risk, so long-term U.S. interest rates are unlikely to be lifted if the dollar falters. Also, in a bipolar world where the growth of advanced economies will be sub-normal for some time, Obama’s promise cannot possibly be delivered without a more competitive exchange rate. The dollar is 7.5% weaker now against the yen than when Obama spoke, but the greenback is also 2% stronger on balance against the euro and down just 2% on a trade-weighted basis. Moreover, six months after the promise was made, U.S. exports had advanced just 3.4% above their level in January. At that pace of increase, exports will climb 40%, not 100%, in a period of five years.
Dollar depreciation also makes sense from a global economic standpoint. Everybody wants a weaker currency from Europe to Asia, Latin America, Europe and North America. It is not possible for each government to get its currency wish. One currency’s fall is another’s rise. A global referee looking at the whole picture would want countries with the largest current account deficits to get priority status in depreciating their currencies. The big surpluses of China, Japan, and Germany cannot build up indefinitely while the United States and peripheral nations in Europe pile up deficits. Such imbalances lead to financial crises like what hit Latin America in the early 1980s, Asia in the late 1990s and the whole planet in 2008-9. Markets do not think altruistically but eventually tend to deliver results that prevent unsustainable trends from going on forever.
The yen is a special case. Appreciation aggravates Japan’s deflation, but that’s only part of the story. Japan also is still running chronic current account surpluses of 3-4% of GDP every year. Because Japanese prices have been falling for more than ten years while prices elsewhere were rising and because this internal boost to price competitiveness on international markets was not nearly offset by exchange rate gains, the yen is quite undervalued. In that context, Japan’s two rounds of intervention thus far were acts of provocation for other governments, which did not intervene. Unilateral intervention is constraining the yen’s flexibility to rise against the dollar and euro, but it is unlikely to push the currency back to 90/USD or softer as Japanese officials would like. Key levels to watch are the mid-September high of 82.87 and the 1995 all-time peak of 79.85.
Two currencies that held generally steady against the dollar last week were sterling and the Canadian dollar. Britain is a test case because fiscal policy will be much tighter there than anywhere else, and that creates a possibility of a British recession or at least significantly weaker economic growth in the U.K. than elsewhere. That also makes the Bank of England and Fed soul-mates as policymakers in both institutions contemplate the merits and risks of quantitative easing. The Canadian dollar faces technical headwinds, namely its proximity to unity against the U.S. dollar. Canada’s economy has slowed rather abruptly, and that’s an additional negative factor for the loonie in the near term.
Hold on to your hat.
Copyright Larry Greenberg 2010. All rights reserved. No secondary distribution without express permission.