Traders Beware, It’s August

August 3, 2012

Strange and unexpected things just seem to happen in August.  Maybe it’s the heat.  Maybe it’s because so many market players are on holiday and away from the office.  Maybe it’s because the dog days of late summer lull people into thinking that nothing much is going to happen.  Dollar/gold convertibility ended 41 years ago this month.  Many intra-European currency crises began to churn in August.  The 1990 invasion of Kuwait, failed Soviet coup in 1991 and start of both world wars came in August .  There’s a tradition of traders being wrong-footed during the month.

This Wednesday will mark the fifth anniversary of the onset of the global financial crisis.  The dollar initially performed weakly across the board, even sliding almost 14% against the euro to its all-time low of 1.6038 per euro in July 2008.  Over the whole past five years, however, the dollar has on net strengthened by nearly 12% against the common European currency and soared by almost 30% against sterling, which was marginally above $2.00 in early August 2007.   The dollar’s overall performance over these five years remains checkered, nonetheless.  Substantial losses of around 34%, 19%, and 18% have accrued against the yen, Swiss franc, and Australian dollar.  The loonie and kiwi are also firmer now than five years ago against the U.S. currency.  One should interpret dollar appreciation against the euro over the past four years as a vote of no confidence in Europe, not an expression of confidence in the United States

In times of low inflation and inconsequential interest rates such as these, currency depreciation carries no stigma.  Policymakers in fact are more fearful about relentless currency appreciation, and steps have been taken in a number of places to resist upward currency pressure.  Notable examples involve  Japan, China and most especially Switzerland.  Data released by the Swiss National Bank suggest that CHF 3.1 billion has been spent daily in intervention lately.  Attention has also been directed to evidence of efforts by Swiss monetary authorities to swap out some of the excessive build-up of euros from this intervention activity for other currencies.  Currency-sensitive monies are notably getting acquired in this manner, and this secondary re-balancing of the composition of Switzerland’s currency portfolio is believed to be an important factor amplifying the disparate dollar performance against the euro and sterling on the one hand and the kiwi, loonie and Aussie dollar on the other.  All this highlights why the currency markets oftentimes feel like a game of craps, bouncing around at a random pace and often counter-intuitively when juxtaposed against the flow of economic news.

The main fundamental economic influences on the dollar remain the euro growth and banking crisis, indications that global demand is softening, and speculation about upcoming changes in monetary and fiscal policies.  These factors are all inter-connected.  Today has seen investor pessimism about growth recede on mounting optimism that central banks may soon provide aggressive support to boost demand, reduce those long-term interest rates that are too high, and fortify banking institutions.  Regarding Europe, I do not share this positive spin and think the euphoria will prove temporary.  Number one, data like the PMI surveys still accentuate the negative.  Number two, the common currency project remains crippled in two permanent respects.  Competitiveness in the struggling peripheral economies will not be restored unless Germany greatly modifies its approach to demand management, which is only a remote possibility.  Also, the experiment more generally lacks the proper voter mandate that massive changes in sovereignty require. Politicians cannot deliver demanded reforms because the people who elected the leaders do not want those changes to be made.

As for the United States, fiscal policy is not going to change before the next election, and prospects for greatly improved governance afterward appear dim as well.  Part of today’s dancing in the market streets reflected hope that the Fed will embark on QE3 in September in spite of political factors favoring no action then.  If any easing is done next month, officials will be risking accusations of election tampering;  in September 2008 meeting when the economic backdrop was much worse than now, monetary officials stayed on the sidelines.   Yet a third element in the perception of better U.S. circumstances was today’s labor market report, specifically a 163K rise in jobs last month.  Although the largest gain in five months, the three-month average rate of rise fell to a six-month low, and the six-month average monthly gain was the third smallest since August 2011 and only exceeded by the results in June and May.  Meanwhile, the jobless rate rose to 0.2 percentage points more than April’s level, and and both the labor participation rate and ratio of workers to population fell further.  Wages only edged 0.1% higher, so all in all, this was not a stellar set of data.

The picture elsewhere around the world is not encouraging, either.  Numerous emerging economies, notably China and Brazil, are operating in a lower gear.  So are Australia and Japan.  It was widely predicted that the world as we know it changed permanently after the September 2001 Al Qaeda attacks.  Looking backward from August 2012, it seems that an even more significant Rubicon was crossed in August 2007.  It has become much harder for political institutions to survive, and compromises that could deliver economies out of the current darkness aren’t happening because political and business leaders no longer have incentives to make a deal. 

The best predictor of future currency performance amid ever-mutating variations on a theme of debt deleveraging is how they’ve performed over the last five years.  The United States economy handled 2007-2012 better than other economies, as it is likely to manage doing in the future.  The euro has fallen, as it must in the future to facilitate reform and transformation in whatever common currency area emerges.  Many European economies are close trading partners of the euro area and caught up in the maelstrom of similar debt deleveraging, so the fate of their currencies will mirror in part the weakness of the common currency.  As for the dollar, its true colors have not been bright when excluding its relationship against the euro, sterling, and other beleaguered European monies.  That, too, is likely to continue.  There will of course be surprises.  The unknowns that cannot even be imagined now will be important shapers of currency market trading, and its best to realize that some of the biggest surprises originate in the month of August.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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