Unresponsive Currencies

April 18, 2013

The wonderful thing about currency markets is the virtually limitless range of determinant factors, and these have been days full of unprecedented and unexpected developments.  The continuing inertia of several key dollar relationships is thus surprising, and that suggests a structural reduction in the intrinsic volatility of currency movement.  The table below compares current dollar quotes to period averages for April, the first quarter, the final and third quarter of 2012, and the first half of the year.  Excepting the yen, whose movement has been engineered by Japanese policy changes, and sterling to a much lesser extent, currency inertia is observed.

USD vs EUR JPY CHF GBP CAD AUD CNY
Now 1.3047 98.22 0.9318 1.5279 1.0266 1.0300 6.1810
April 1.2990 97.08 0.9365 1.5282 1.0280 1.0443 6.1950
1Q13 1.3200 92.30 0.9305 1.5514 1.0083 1.0384 6.2237
4Q12 1.2974 81.22 0.9311 1.6057 0.9913 1.0442 6.2474
3Q12 1.2559 78.62 0.9627 1.5793 0.9960 1.0389 6.3526
1H12 1.2970 79.81 0.9301 1.5765 1.0061 1.0326 6.3209

The above stability contrasts with a very colorful flow of informational shocks.  Wide currency swings haven’t been missed for a lack of cause.

Geopolitics are in a state of chronic inflammation.  Last year’s Arab spring ushered in chaos rather than peace.  The United States was rocked this past week by two disasters, each producing over 150 injuries.  North Korea threatens nuclear attack to anyone within reach, including Japan.  Monetary union in Europe has created tension in that region instead of economic harmony.  China and Germany continue to flex muscle in Asia and Europe, respectively.  Japan, too, has a more nationalistic political leadership.

The pre-Great Recession global recession failed to return.  Growth is weaker, especially among older developed economies, but China also is transitioning away from its post-1980 norms.  Bloated budget deficits are evoking ill-advised fiscal choices, and the escalation of central bank balance sheets is generating considerable anxiety.  Fear of deflation and inflation — tautological polar opposites — co-exist.  Investors want to believe that inflation is around the corner because that’s a world with which they are familiar, but the truth is that deflation continues to be more prevalently in evidence a la low inflation, low long-term interest rates, and weak nominal and real GDP growth.

Savers are grappling with an investment world where there’s no safe place to hide.  Bonds are believed to be in a bubble just waiting for the first hint of a monetary policy turnaround before bursting.  Until this week, equities felt like the proverbial cartoon character that has run past the cliff’s edge but continues to levitate until it looks down.  Gold is trading more than 25% below highs in the third quarter of 2011 in a further sign that neither dollar devaluation nor excessive inflation is a clear and present danger. 

Governments are taking a greater hands-on approach to currency management, which means that currency equilibrium needn’t occur at the level that clears natural supply and demand because governments are not afraid to influence the psychology that shapes market forces.  To their credit, governments have avoided the blatant trade protectionism of the late 1920s and 1930’s, and G20 central bankers and finance ministers this weekend will no doubt reaffirm their collective pledge to avoid such practices.  That said, domestic policies that change currencies have occurred in Japan and Switzerland without foreign repercussions, and China continues to closely direct the yuan.  The reputation is breaking down that currency intervention is pointless unless undertaken in a coordinated way or in a complementary way with economic fundamentals.

This week may have seen the beginning of enhanced event risk in the United States and/or the start of a significant down-leg in stock markets.  For what it’s worth, the dollar advanced 8.1% against the yen and 1.3% relative to the euro between September 11, 2001 and the end of that year.  Likewise, the U.S. currency rose 12.1% against the euro but fell by 7.7% against the yen during the plunge of U.S. share prices between the collapse of Lehman Brothers in mid-September 2008 and early March 2009.  Those periods constitute the extreme cases for markets governed by geopolitical unrest and bear equity markets.  Given the insularity of currency markets from what’s happening in the real world, such precedents will probably not be especially helpful.

For someone who’s been commenting on currency movements for nearly forty years, it’s with some irony that in this age of ease for anybody to try their luck at making money trading foreign exchange that the big waves of yesteryear have gone away.  All the information one needs are but a keystroke away.  There is a proliferation of foreign exchange schools where one can learn this trade.  All that’s missing is that one huge swing to be ridden.  Perhaps it could still be the fall of the yen, but resumed weakness seems to be waiting now for evidence that the Bank of Japan can really depress interest rates over the whole maturity spectrum and keep reinvigorating Japan’s economy and stock market.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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