Can a Dollar Floor Be Found Soon?
October 22, 2010
Last week was just full of surprises. Monetary policies around the world became more diversified. A tightening interest rate cycle began in China, and ECB officials showed more willingness to scale back unconventional measures. Other central banks, for example those in Canada and Brazil, put rate normalization programs on pause, and a third group including the Fed and Bank of England inched closer to undertaking new quantitative easing. Differences also were manifested on the data front. Several German releases depicted continuing brisk activity in Europe’s largest economy well past the point that a pronounced deceleration had been anticipated. In Britain, however, where plans for massive government spending cuts and higher value added taxes represent a huge leap of faith, softer-than-expected retail sales suggested that households are already bracing for the worst.
Accusations of competitive devaluations continue to fly back and forth, while a meeting of G20 finance ministers in South Korea created an opportunity for event risk, especially after the United States recommended the targeting of current account imbalances. Treasury Secretary Geithner also toughened his strong dollar rhetoric by asserting that the U.S. currency is fairly valued against the euro and yen. Prospects for a meaningful policy breakthrough among a group of nearly two dozen governments seem remote, but leaders are at least still talking. Real warfare only begins when negotiations stop.
The week ahead is the final one of October and thus has a very crowded calendar of scheduled data releases that in particular features the first estimates of third-quarter GDP growth in the United States and Britain, the Bank of Japan’s quarterly economic forecast, and readings on Euroland economic sentiment, inflation, and unemployment. The flow of public comments from officials will be in high gear, not just in the aftermath of the G20 conference but also because Bernanke, Trichet, and Shirakawa are among a large list of central bankers with scheduled speaking engagements later in the week. This is the last full week before a U.S. election that polls suggest will be delivering a landslide defeat for the Democratic Party. U.S. fiscal and regulatory policy decisions in the final nine weeks of 2010 remain very uncertain but promise to have enormous and long-ranging ramifications.
In the currency market trenches, a number of big figure levels — $1.40 per euro, JPY 80/USD, and dollar parity against the Swiss and Canadian monies — have emerged as critical guideposts for assessing the winners and losers of these war games.
- Amid the swirl of uncertainty, the dollar stopped falling against the yen and euro, which was good enough to stabilize the yuan’s dollar value as well even though the U.S. Treasury in good faith delayed its semi-annual currency market assessment. So harsh criticism against Chinese policy was avoided at this critical juncture. 2009 was a bad year for China, yet GDP expanded 9.1%. Over the first three quarters of 2010, GDP went up 10.6%, and a softer on-year advance last quarter masked a significant quickening of the underlying quarterly pace. CPI inflation has meanwhile risen from 1.5% in January to 3.6% and is headed higher, solidifying the need for tighter monetary policy. The conservatively-minded officials in Beijing will most likely continue dragging their feet on calls for yuan appreciation, having let it rise 2.6% since agreeing to end a 2-year freeze versus the dollar in mid-June. The yuan’s gains since July 2005 when a much longer period ended of being fixed to the dollar amounts to just 4.3% per annum.
- The greenback rebounded sharply on balance for the week against sterling, the Swiss franc, and commodity-sensitive currencies. The euro by today had moved back to the high 1.30s and never got closer than a penny from the prior week’s cyclical high of $1.4157. While some analysts foresee a euro slide to the very low 1.30s by yearend, I anticipate a path in the high 1.30s or above. Unlike the Fed, BOJ, or Bank of England, ECB policymakers are not tempted by quantitative easing. Germany’s resilience should embolden the hawkish Council members to steer policy toward greater normalization instead.
- For a fifth straight week, dollar/yen set a new low for the move, eclipsing the prior week’s trough of 80.90 but by only a mere five pips. The all-time low of 79.85 has been tantalizingly close without triggering another big round of intervention support. One has to wonder if officials are acting discretely through Kampo, the postal service, or in some other indirect way to keep the yen from crossing the 80/USD threshold. Japan releases many statistics at the end of next week.
- The Canadian dollar has traded under 1.05 per USD for part of every week since early February but never got stronger than 0.9931 and has not strengthened through parity since the beginning of May. This prolonged interval of very narrow movement in a range close to 1:1 is a throwback to the 1960s and first half of the 1970’s, only it’s being preserved now by market forces. Since 2000, the loonie has traded as weakly as 1.6194 on January 21, 2002 and as strongly as 0.9061 on November 7, 2007.
- The Swiss franc and Canadian dollar were trading neck-and-neck for much of this year, but the franc moved under parity with the dollar at the beginning of this month and got as strong as CHF 0.9541/USD this past Monday, a rise of just over 11% since just before mid-August. It’s not surprising that this week’s corrective rise of the dollar ahead of the G20 meeting would have been disproportionately large against the Swiss currency. It’s fate from here, and that of gold, will hinge on whether G20 officials produce a credible plan for stopping further dollar slippage. The odds do not favor this, and who would be better than the Swiss authorities to know that it takes more than intervention to control the foreign exchange markets? Heavy Swiss intervention earlier this year proved to be very unprofitable.
- Having peaked at USD 0.9961 on October 19, the Australian dollar has still not reached the elusive summit of USD parity, but few analysts, including me, think it has run out of steam. With officials trying to rewrite the script of foreign exchange movement, the trading landscape has become more complicated and less predictable. But over the coming year, Australia is a good proxy for betting on the Chinese economy, which weathered the great recession much better than expected. Australia was one of very few economies that did not share in that global downturn. In the land of the blind, Australia is the one-eyed king. Unlike Canada, it can decouple from the weakening prognosis of the U.S. economy. Australia’s cash rate of 4.5% is high by the standard of most other economies, and the premium is going to be wider three to six months from now.
- It has been observed that in the homeland of John Maynard Keynes, current political officials are ironically ignoring Keynesian economics more than leaders in any other place. In the wake of the world financial crisis, the U.K. economy is no less fragile than any other. Because Britain suffered one of the largest peak to trough losses of GDP among advanced economies, it can in fact be argued that the fragility is comparatively higher. The extreme tightening of fiscal policy over the coming four years, which if all goes according to plan will cut the deficit from about 10% of GDP to less than 3% of GDP, can be balanced by expansionary monetary policy only if the pound depreciates sharply further. With a base rate of 0.5%, the conventional channels of monetary stimulus fit the proverbial “liquidity trap” model described by Keynes and cannot be counted upon to lend much lift. Thankfully, Britain’s experiment is being undertaken. Economists will learn a great deal about policymaking in unchartered waters that will serve all countries well in the future. Thankfully, Britain and not the United States or Japan or China is the guinea pig. If something goes wrong, the whole world economy will not pay a price for the misdeed. By 2015, Britain’s Conservative government will either be hailed as geniuses for boldness and prescience, or the leaders will be scorned as irresponsible ideologues who defied history and the opinion of many experts and also for making a country pay an enormous price without securing the intended fiscal deficit reduction.
Copyright Larry Greenberg 2010. All rights reserved. No secondary distribution without express permission.