T Minus Seven Days and Counting

December 2, 2011

The euro’s survival will top the agenda at the December 9 summit of EU leaders, but opinions vary widely on the terms and last possible timing for meeting that goal.  Investor want a quick resolution, and their patience is running thin.  Europe’s sovereign debt crisis has festered for two years, far too long already, and the idea is crystallizing that this month’s summit constitutes the last hope for avoiding a break-up of the common currency.  That’s a dangerous mind-set for a problem known for missing deadlines and producing agreements subject afterward to widely diverging interpretations.  Much more is at stake than Europe’s regional economy.  Central banks and political governments throughout the world have singled out the euro crisis as their top risk factor and, in some cases, warning that Europe’s failure to find common ground could subject the global economy to greater fall-out than the 2008-09 mortgage loan mess.

It does not seem possible to deliver a credible rescue plan without significant concessions by Germany’s leadership and ECB officials, each of whom categorically rejects a lender-of-last-resort role for the central bank or the issuance of joint euro bonds.  One of those actions is needed to buy time to establish fiscal unity and a greatly empowered central government to carry out many of the functions that are currently under the jurisdiction of the member governments.  This brave new world was envisaged by the designers and proponents of Economic and Monetary Union, including former German Chancellor Kohl, but the citizenry of Europe was not given ample information on this or the chance to adequately authorize such a profound shift of sovereignty. 

Two huge residual problems now block the road to solving the euro debt crisis within a week, one being the original sin of not securing a proper mandate for the project.  Seven days is way too little time to repair that oversight.  The other hurdle is the wide diversity in competitiveness among EMU members that must be trimmed substantially and cannot be done exclusively by subjecting Greece, Ireland, Spain, Portugal and Italy to endless austerity and recession without Germany also undertaking profound behavioral changes.  German officials have to acknowledge that a credible rescue of the euro must entail steps that will enduringly slash that country’s chronic current account surplus.

Such concessions are also unlikely to emerge next week, so the eventual break-up of the euro seems probable.  The uncertain timing of the EMU’s demise creates choppy, indecisive currency market conditions.  A failure by politicians to communicate and compromise in America is another reason why the euro debt crisis hasn’t produced more decisive shifts in currency relationships.  EUR/USD will continue to be judged by whether it is stronger or weaker than 1.3500.  Penetration of that level earlier today proved fleeting, and so it remains close to its 2010 mean of $1.3258.  The November average was $1.3553, and the year-to-date average of $1.3986 is similar to the 2009 mean of $1.3942.  Cable is now near its 2009 and 2010 averages of $1.5659 and $1.5448.

Commodity-sensitive currencies, by contrast, have demonstrated less random price action.  The Australian dollar, for example, rose from USD 0.7932 on average in 2009 to means of USD 0.9203 in 2010 and USD 1.0143 so far this year.  Whether such buoyancy continues hinges on the global economy, which would take a hit if European negotiations break down.  Newfound optimism about U.S. prospects meanwhile need to be guarded, too. The sharp decline of the U.S. jobless rate in November was largely caused by a shrinking and presumably discouraged labor force, which is hardly auspicious.  Employment has risen at an annualized rate this year of 1.2%.  Seven of the last eleven years saw jobs grow more slowly than 1.2%.  However, the trend growth of jobs over the final twenty years of the last century was 1.84% per year, which translates to a monthly increase of about 200K at present.  Jobs grew 120K in November and by 114K per month over the past six months, so the U.S. jobs deficit continues to widen.  If the 1.84% annual rate of increase from end-1979 to end-1999 had continued, there would be 30.48 million more jobs than now in the United States. Such a shortfall from trend is as large as five-sixths of California’s population or three-quarters of reunited Germany’s total number of employed workers.

The yen and Swiss franc have shown more direction than the dollar, euro, or sterling, and that has prompted intervention this year by officials in Japan and Switzerland.  The franc recorded annual averages of 1.0861 per dollar in 2009, 1.0428 in 2010 and 0.8772 so far in 2011, but after Swiss authorities announced a franc ceiling in early September of 1.20 per euro, the dollar recovered from CHF 0.8440 to CHF 0.9330.  It also recorded an average value last month of CHF 0.9081, which is near to its present quote.  The yen’s evolution saw it strengthen from means of 93.61 per dollar in 2009 to 87.67 in 2010, 79.90 so far in 2011, and 77.5 in November.  The threat of Japanese intervention for now has imposed a range bordered by 75.5 and 78.5.

Currency sensitivities have affected policies in emerging markets, too.  China seems to have suspended the managed crawling appreciation of the yuan against the dollar just as happened during the Great Recession.  After a 0.5% drop in October, the yuan firmed 0.2% last month.  In Hungary, the central bank raised its key interest rate by 50 basis points this past Tuesday in order to lend support to the faltering forint. 

2011 has been a difficult year for currency traders because of the lack of cumulative movement, the extreme choppiness of prices from day to day, and the dominance of headline risk as politicians jockey for policy advantage and take their cases to the public.  It is normal in December after currency traders wrap up speculative activities for volume to thin after mid-month.  Given current circumstances, this factor may start earlier in the month than is typical.  During the weeks of thinner volume, moreover, a slight downward bias in the dollar is often seen.  Since the euro was launched, it has risen against the dollar 8 of 12 times from mid- to end-December and has posted an average advance of 1.0%.  Over the prior 26 years, the dollar fell in the second half of December 18 times against the mark and by 0.9% on average. 

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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