U.S. Thanksgiving Break Finds a Confusing Currency Muddle
November 19, 2010
All the major currencies are carrying some piece of negative baggage. The Fed is running an easier monetary policy than other central banks without commensurably weaker U.S. growth prospects. Sovereign debt strains are slamming Euroland’s so-called peripheral economies one by one, generating some doubt that the euro will hold together indefinitely. Persistent Japanese deflation was associated with real economic growth in the world’s third largest economy of only 0.8% per annum over the fifteen years between 3Q95 and 3Q10, a period when the Bank of Japan’s overnight money target never rose above 0.5%. Britain is about to be dragged into the fiscal unknown with its greatest fiscal retrenchment since the Second World War. China and India have genuine inflation problems, and the risk that Chinese officials might over-steer the cool-down presents some danger to commodity-sensitive economies and ones that do a lot of business with China. Australia qualifies on both counts, and the Aussie dollar is again trading just shy of USD parity.
Market participants need to discern whose negatives are more threatening to currency life and likely to linger the longest. Fed policy has been set broadly through mid-2011. The Fed’s quantitative easing continues to draw lots of second-guessing from people far less credentialed than Bernanke, but that hasn’t prevented periodic bouts of dollar brawn, such as during this past week when the greenback recovered about 1% against sterling, the yen and Canadian dollar, closer to 2% against the Swiss franc and around a half percent versus the euro.
Euro area leaders have been groping clumsily through the sovereign debt crisis. The euro has been a pawn of the crisis, giving up ground when market and diplomatic strains become most frayed. The problem demands a fix, in fact a series of repairs. One crescendo in the crisis, focused on Greece, occurred last May, and the euro performed well for a while after that squall passed. While it does not look like half-year respites will occur in the future, it is also possible that officials will contrive an arrangement that is less country-specific and more adaptable to all the governments. Details remain unclear, but two ground-rules seem reasonably certain. A default or a member defection within the next three to six months appears extremely remote, and a respite will be fashioned before the Fed completes quantitative easing. Conventional wisdom is already pricing in an ECB rate increase sooner than a tightening at the Fed in spite of somewhat faster economic growth in the United States than euro area.
Sterling has had a load lifted from its pack. Until recently, it had seemed that both the Fed and Bank of England would be buying more long-term assets, the latter in part as a partial antidote to the coming fiscal medicine. The Fed will have no such company from the U.K. at least until mid-winter, most likely longer, and perhaps ever. Bank of England officials have been surprised by a string of better-than-assumed British data and have become more worried about how long U.K. inflation remains above 3% and the chance that such lifts expectations of inflation.
The U.S. Thanksgiving break ushers in the yearend currency market season. Market players will be thinking harder while on break about likely trends in 2011. Accounting considerations will influence trading to an increasing extent in the weeks ahead. This period can make or break a whole year for retailers. In the United States, Thanksgiving is a holiday when scattered families reunite, often traveling far, and impressions are shared about how different sections of the country are doing. After this reality check, more keenly focused views on the economy are carried back to the boardroom and trading floor.
Beijing officials have increasingly difficult decisions to make. China’s economy didn’t cool quickly or sharply enough to forestall inflation, which within nine months tripled from 1.5% in the year to January to an on-year pace of 4.4% by October. Inflation, which was a background factor in the pre-Tianmenan perod, is taken very seriously and will be addressed until something proves effective. Foreigners would like the yuan to climb faster, but the Chinese have leaned most heavily on administrative guidance and higher bank reserve requirements. Interest rate increases beyond the single 25-basis point hike so far can also substitute for currency appreciation. Any sign of caving into foreign pressure on yuan policy might be interpreted as a sign of weakness and could erode the leadership’s paramount goal of preserving domestic order. It is doubtful that Chinese officials will end the heavy buying of securities associated with their forex policy, and an incentive persists to deploy part of that into the euro and other non-dollar assets, and that will continue to weigh on the dollar.
The dollar is not far below its value last Thanksgiving but has fallen much more substantially in comparisons with pre-financial crisis average levels. On Thanksgiving Day 2009, the dollar was worth 1.3017 per euro and JPY 86.6. To get a sense of the dollar’s underlying pre-crisis value, I took its averages from the beginning of 1999 when the euro was launched until mid-2007. Compared to those means, the dollar has depreciated by 33% and 26% against the Australian and Canadian dollars, 30% versus the the Swiss franc, 27.5% against the yen and just over 19% against the euro. Those big losses do not make the dollar necessarily undervalued now, since its long-term directional movement was downward even before 1999. Also, U.S. economic problems and prospects seem far worse now than then, and America’s current account remains in chronic excessive deficit.
Conventional wisdom thinks the dollar will probably lose more ground next year against the euro. Betting with the pack all too often is a losing strategy in foreign exchange. As for the yen, Japanese officials deserve some credit for a successful defense so far against appreciation through the all-time yen peak of 79.85 in April 1995. The resistance of that level is reminiscent of the stubbornness shown previously by the 120 per USD barrier, first touched at the end of 1987 but not broken convincingly until 1993.
From the standpoint of what brief time remains of 2010, two important market considerations will be the fate of the Bush tax cuts and seasonal tendencies, if any, in the dollar. The two U.S. political parties have been playing a game of chicken over taxes, which would rise sharply if no legislation on the matter gets approved. Investors are also engaged in a parallel game of chicken, delaying decisions in hopes of some clarification of the law but not waiting until the last possible moment of the year when liquidity can be quirky. A risk exists for sharp sudden shifts in equity prices that could drag the dollar in lock-step given its propensity to trade inversely with equities. Historically, the dollar has exhibited some tendency to weaken in December against European currencies. This pattern was most reliable from 1974 through 1987. In the noughties, the euro rose against the dollar in eight of ten years but just once since the financial crisis began. In 2008, the dollar fell by 7.8% between Thanksgiving and New Year’s Day but it rose 4.9% last year and by 1.6% in 2007 during the inter-holiday weeks. Dollar/yen also rose in that portion of 2007 and 2009 but fell in 2008. There were an equal number of years last decade when the yen appreciated and depreciated in post-Thanksgiving trading.
Copyright Larry Greenberg 2010. All rights reserved. No secondary distribution without express permission.
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Dear Sir Larry Greenberg,
When fed auctions the bills,Notes/bonds & Tips does it have any effect on country’s currency i mean on usdx?
Drawing criticism from people “far less credentialed than Bernanke”??? Are you serious?
Was this the credentialed fellow who assured us the subprime contagion was well contained?
I would take the word of any high school grad with some common sense above the out of touch opinion of PhD Bernanke any day. Clearly, a PhD is not all it is cracked up to be.