The Movement of Euro/Yen

December 5, 2013

Yen weakness and euro resilience have coexisted for the past sixteen months.  From a low of 94.075 yen per euro in late July 2012 to a high this week of 140.025, the euro soared 49% against the Japanese currency, rounding slightly up to the nearest whole number.  With hindsight, the trigger for the turning point is clear, as the trend started when ECB President Draghi declared that the central bank is prepared to do whatever it takes to save the euro.  Sixteen months ago, investors perceived a likely probability that the euro would break apart, and that possibility — rather than the bad loan portfolios of European banks, street unrest against fiscal austerity and recession, or damaged relations among regional political leaders — lay at the heart of Euroland’s utterly fragmented financial markets.  The market response to Draghi underscores an important market lesson that words can be as or more powerful than policy deeds.  ECB actions haven’t matched the open-ended dare of Draghi’s message.

While the initial catalyst for the resurgence of EUR/Yen emerged in Europe, the yen has experienced a more transforming journey than the euro.  The trade-weighted yen has dropped 9% since June 13, 21% from a year ago and almost 27% since July 24, 2012.  Against those same base dates, the trade-weighted euro has respectively risen 1.6%, 5.0% and 9.4%. 

The yen’s greater movement illustrates the risks of assuming that strengthening economic growth in relative terms ought to translate into currency appreciation, and vice versa.  Oftentimes, as in this case, causation runs in the opposite direction.  The euro area economy has struggled more than Japan’s in part because of the direction currency movement.  The softer yen creates the hope that Japan’s trade position will improve, even though it has done so thus far to a frustratingly scant degree.  Euro appreciation has turned the tourniquet further for the region’s uncompetitive members and led to ever-widening balance of payments disparities within the currency bloc. 

Yen weakness was greatly augmented by the implementation of Abenomics, particularly the monetary dimension of the strategy, which began eight months ago, that is halfway between Draghi’s July 2012 speech and now.  A lesson of currency history in the first two decades of floating dollar exchange rates is that while it can be very difficult for policymakers to stop a weakening currency’s drop, no excuse exists for failing to cut down a currency uptrend that has become damagingly excessive.  Central banks influence the supply of their own money relative to foreign monies and have the wherewithal to flood markets with currency at a pace that outstrips market demand.  Ergo, the exchange rate eventually succumbs to the relentless mismatch of supply and demand and seeks equilibrium at a softer level.  The catch is that policymakers may lack the will to subordinate all other priorities for the sake of a depreciating currency, but a lack of means is not the real problem.


Comment on Fed Tapering

The taper watch is back in full force, thanks to better U.S. labor market news and other upside data surprises.  Three-fourths of the half-percentage point retreat of the ten-year Treasury yield that followed early September highs has now been recouped, and we are back to levels seen four months ago.  The jobless rate is 0.3 percentage points lower than then, and the four-week mean of new jobless insurance claims is 24K less.  Real GDP in the U.S. expanded 3.0% at an annualized rate between 1Q13 and 3Q13, five times faster than the annualized advance of 0.6% in the previous half-year period.  Rotations in the voting FOMC members will initially result initially in a more hawkish decision-making body than the current configuration, and new Fed Chairpersons always seems cognizant of the need to establish an anti-inflation image early in their tenure.  Policymakers also think that the benefits of tapering has lately been yielding diminishing benefits as a stimulus.  There hasn’t been a protest by officials against the renewed upward creep of bond yields, and the series of equity losses is likely welcomed given the public debate about whether prior gains signify a dangerous asset bubble.

Alas, the case for tapering is not so clear-cut, and even if agreement emerges on starting the process, that merely bumps the cutting edge of policy to the matter of how quickly and how steadily to pare down monthly asset purchases.  U.S. data in fact remain quite mixed.  Fourth-quarter growth seems less frisky than in the summer, especially from the perspective of personal consumption.  Consumer spending only rose 1.4% annualized in 3Q and by 1.8% over the past four quarters.  Faster inventory building ($59.9 billion compared to $14.4 billion) accounted for half the rise in GDP during the summer and may have happened unintentionally.  GDP rose just 1.8% per annum over the past 13 years, including a 2.3% pace during the present 4+ year recovery.  Other data like factory orders, which fell 0.9% in October, have been subdued.  More importantly, inflation is still too low.  The total PCE price deflation and headline personal consumption deflator posted on-year rises of 1.1% and 1.2% last quarter, down from 1.6% and 1.8% a year before.  CPI and core CPI inflation lie closer to 1.5% than 2.0%. 

Enough uncertainty persists that tapering, even after it is started, will be modified if markets fail to embody the segregation of lessening quantitative stimulus from a strong aversion to raising the fed funds rate for a considerable time after QE ends.  An acid test for whether investors get this concept will be the steepness of the Treasury yield curve.  The protest in September against a 3-handle on the 10-year Treasury had elements of level and speed of climb.  Context has changed since September, so 3.0% isn’t a line in the sand.  What does seem true, however, is that there will continue to be limits to Treasury market movement that Fed officials will allow.  Relative to whatever happens in U.S. growth, jobs and inflation, Fed officials will endeavor to engineer a monetary policy that is more accommodative than one would have ordinarily expected before the financial market crisis and Great Recession.

All this seemingly should leave the dollar limited on the upside against the euro.  Even as the 10-year T-yield nears 3.0% again, the euro at $1.367 at Thursday’s close was 4% weaker than its level on September 5 when the 10-year yield first arrived at the doorstep to 3%.  The decline versus the euro exceeds the concurrent net rise of 1.7% against the yen.  Beyond yearend looms another possible political game of chicken over raising the U.S. debt ceiling.  The mess surrounding the Obamacare website might embolden the president’s Republican opponents to take a harder stand than now imagined.

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

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