No More Fun Watching Currencies

August 15, 2013

The thrill is gone for long-time dollar watchers like myself and not because of a lack of interesting developments happening on the policy front, in economic trends, or to other markets.  Middle East violence is again holding the world hostage both politically and economically.  Europe seems to be emerging from recessions but with its banks still in very precarious shape.  Fed tapering is likely to start next month, but similar inflection points in Japan and the euro area are nowhere to be found.  Japanese monetary policy underwent a previously unimaginable transformation earlier this year.  Germany’s election is just five weeks away, and a month or two later President Obama should be announcing his choice for the next Federal Reserve chairperson. 

Back in the day, currency speculators lived with the possibility of the dollar doubling in value against its main rivals or losing half its value in just a couple of year because these things had happened.  Documented moves of around 7% over a weekend happened.  Within one calendar year, the dollar fell over 20% and subsequently recovered all its losses.  Currency crises aren’t what they used to be like the one 1978 when a full percentage point hike of U.S. interest rates was announced initially by the White House and not the Fed. 

Europe’s common currency to replace national currencies took away excitement that preceded numerous parity reconfigurations in the joint float arrangements known as the “snake” and the “ERM.”  Intra-European currency crises tended to intensify in August when the big players were on holiday.  Sure, the scenario of the European Monetary System breaking apart is ever-present, but waiting for that grand event is a little like watching paint dry. 

Nowadays, the largest currency value discrepancies are between perennial forecasts of dollar-euro parity heard at the start of each year and the very different reality that in fact follows. 

Major dollar relationships have been comparatively trendless over the three weeks since the last currency market essay was posted in this space.  The dollar is now 0.2% stronger than then against the euro and is up by 0.5% versus the Swiss franc.  In contrast, the greenback has depreciated 1.2% against the yen but continues to trade in the upper 90s.  Sterling rose 0.9%, contrary to the intent of the Bank of England’s adoption of data-linked forward policy guidance.  Commodity prices are somewhat firmer and likely to keep climbing so long as the politics of Egypt trembles, yet commodity-sensitive currencies have slipped.  The Chinese yuan is grinding upward at a very measured pace.  A number of emerging market monies like the Indian rupee, Brazilian real, and Indonesian rupiah exhibit continuing softness and vulnerability.

It is a great irony that given the relatively boring arena of foreign exchange compared to the early days of flexible exchange rates, more people than ever have become currency market participants lured by the vast array of on-line currency trading platforms and schools promising easy money to be earned without even leaving the home.  From the vantage point as a market commentator, I used to worry too much would be missed if I skipped writing my weekly currency market newsletter even once.  I stepped away for the past three weeks and see profound fundamental developments but only modest reaction in key dollar pairs. 

Comment on Tapering and the Dollar

The dollar lost ground against the euro while the above paragraphs were composed.  The backdrop to the dollar’s losses today featured falling equity prices, released U.S. data that reinforced expectations of reduced Federal Reserve asset buying after next month’s FOMC meeting, and unrest in Egypt.  Each of these factors in a different context used to boost the dollar.  Beginning currency students are told that higher interest rates support a currency, and vice versa.  Of course, it often doesn’t work that way (see 1994-5).  Monetary tightening, if premature, can be a sign of weakness, and tightening when the last three reported quarters were associated with GDP annualized growth of 1.0% at least creates reasonable doubt that tapering next month would be a safe move.  Although common sense suggests that falling U.S. interest rates would be positively correlated with a weakening dollar, the correlation in fact had been negative for much of the time since 2007.  Middle Eastern troubles cut both ways for the dollar.  Higher oil prices are a problem for countries with a current account and trade deficit, but America’s reliance on imported energy is diminishing.  Moreover, geopolitical tension usually spurs flight to safety capital flows, and that generally favors the world’s preeminent reserve currency.  Looking ahead, an interesting question is whether the Fed will shy away from tapering so soon because of uneasiness how markets will handle such a move.

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

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