Mid-2014 Currency Review
July 2, 2014
Not much was settled in the first half of 2014. Global growth continued to be sluggish. The euro area emerged from recession but just barely, and its members experienced divergent trends. Although expanding rapidly compared to advanced economies and many emerging ones, Chinese growth is several percentage points slower than its old norm, and that matters very much for economies like Australia that depend on Chinese demand. A 2.9% annualized contraction in U.S. GDP, though blamed in large part on weather, was so far beneath analyst expectations that the full-2014 outlook was affected significantly. Japanese data trends were severely distorted by a three-percentage point increase of the national consumption tax on April 1. Abenomics inspires less hope than a year ago.
The persistent slack in the utilization of productive resources, manifested in contained labor costs and subdued inflation, maintained ultra-low interest rates. The ECB eased in June but only when monetary authorities were staring at the prospect of oncoming deflation. Among advanced economies, Britain provided the most significant upside growth surprise, and as the tone of communication from the Bank of England evolved in a less dovish way, investors came to expect a first rate hike in the U.K. before the end of this year. The Federal Reserve, by comparison, is not expected to raise the federal funds rate before the spring of 2015, a long enough interval and one surrounded in sufficient uncertainty so as not to lend the dollar discernible strength. Bank of Japan officials hope to complete their mission by April 2015 but promise to muscle onward with super-accommodative quantitative and qualitative stimulus if that is not the case. Renewed yen appreciation is a worrisome sign for Japan’s economy. Rate normalization began in New Zealand but will clearly not be undertaken in Australia before next year.
Ten-year sovereign debt yields fell substantially between end-2013 and mid-2014, regardless of whether monetary policy had passed the inflection point between sustained massive accommodation for the foreseeable future and the beginning of a public discourse over how and when rate normalization might eventually proceed. Interest rate levels remain too low and too closely bunched to become a meaningful driver of currency movement. This non-sensitivity has been reinforced by low and tightly bunched rates of inflation. Fear has mounted that another asset bubble is ballooning outward. Bond prices look unsustainably elevated, but they also did when this year began. Stocks have done well just about everywhere in the table below, not because of impressive economic growth, whether viewed nominally or in inflation-adjusted terms, but because there is no alternative to riskier investments for consumers who need higher yields or institutions that promise their clients better results. The antidote to an economic environment that fails to deliver job security and minimal income growth is to have had the foresight to invest in risky assets before the hard times came. Households that once lived with the debt genie have been buried by the curse of that same debt.
Two wild cards in the currency market arena are the news-making shocks of geopolitics gone bad and foul weather events. The first of these is not new. Geopolitical tensions can be counted upon to happen one place or another almost all the time, and the Middle East since the 1960s has been a house of horrors. Western leaders are perennially blamed for mishandling relations in the Middle East, but government after government, whether conservative or liberal, have failed to deliver sustainable progress toward a lasting solution. The best one can hope for is a stance that runs to stand still and passes the situation on to the next team of political leaders no worse than what was inherited. Markets have become desensitized to Middle East madness. It seems nowadays that only if oil prices tumble or soar do currency relationships adjust in a meaningful way to political turmoil in the Mideast.
Many of the bad elements of global warming, such as increasingly frequent violent weather extremes, are happening already. Viewed in that way, the sharply negative economic growth in the United States last winter, was not a random event. One doesn’t have to wait a whole year for another possibility of weather havoc causing the economy to grow more slowly. Perhaps summer will see an abundance of tornados, drought and hurricanes. The evidence is strong that the activities of people are the principal cause of global warming. Substantial behavioral shifts are needed in the United States and China to start a process that will eventually cap global warming and its adverse repercussions on economic life. Even if such action began in earnest now, it will be decades before the trend in weather patterns stabilizes and becomes less violent and erratic. However, the United States is not inclined to change radically now because the its fastest-growing political movement, the Tea Party, believes that global warming is a figment of the imagination of liberals. The bottom line is that weather events will be increasingly intrusive on all walks of life, and the counter-attack against the problem will spring from the force of intolerable circumstances many years from now rather than a preemptively designed response. For now, currencies aren’t reacting to the extremes of Mother Nature.
In fact, as seen below, net currency movements so far in 2014 have been rather minor. It hasn’t been so because of an absence of economic surprises or a lack of wild card developments. In part, analysts seem to be prioritizing the wrong factors. In the 1970s, 1980s, and 1990s, a chronic U.S. current account deficit was associated with a long-term erosion of the dollar’s value. In circumstances that otherwise would be expected to be lifting the dollar now, it fell somewhat on balance in the first half of 2014 against most of currencies shown below. Between the final quarter of 2013 and the first quarter of 2014, the external deficit as a ratio to GDP rose 0.6 percentage points to 2.6%. Also worth noting, periods of dollar strength such as the early 1980s and the latter 1990s correlated with times of good voter approval for the president. Pundits still disagree over the success of the Obama Presidency, but the popular image, which is what matters in the arena of foreign exchange, has become quite negative. He’s disliked immensely by his opponents, and supporters view his stewardship as disappointing on both the economy and foreign affairs. The November congressional election will cast U.S. political leadership in an unfavorable light.
| 10-Yr Yield | 07/02/14 | Chg vs End-1Q | Chg vs End-2013 |
| U.S. | 2.60% | -12 Basis Points | -43 Basis Points |
| Germany | 1.25% | -31 | -67 |
| Japan | 0.55% | -8 | -18 |
| U.K. | 2.74% | +1 | -28 |
| Canada | 2.24% | -21 | -51 |
| Switzerland | 0.66% | -30 | -41 |
| 3-month euros | Chg vs End-1Q | Chg vs End-2013 | |
| U.S. | 0.23% | 0 Basis Point | -2 Basis Points |
| Euroland | 0.18% | -10 | -9 |
| Japan | 0.13% | -1 | -2 |
| U.K. | 0.55% | +3 | +2 |
| Swiss | 0.01% | -1 | -1 |
| FX | Pct Chg in USD | Pct Chg in USD | |
| EUR/USD | 1.3649 | +0.9% | +0.8% |
| USD/JPY | 101.77 | -1.4% | -3.4% |
| USD/CHF | 0.8891 | +0.5% | -0.4% |
| GBP/USD | 1.7156 | -2.9% | -3.5% |
| AUD/USD | 0.9434 | -1.8% | -5.4% |
| NZD/USD | 0.8754 | -0.9% | -6.0% |
| USD/CAD | 1.1066 | -3.5% | +0.4% |
| USD/CNY | 6.2110 | -0.1% | +2.6% |
| Equities | Chg vs End-1Q | Chg vs End-2013 | |
| S&P 500 | 1975 | +5.5% | +6.9% |
| Nasdaq | 4457 | +6.4% | +6.9% |
| Djia | 16968 | +3.1% | +2.4% |
| Dax | 9913 | +3.7% | +3.8% |
| Nikkei | 15370 | +3.7% | -5.7% |
| Ftse | 6818 | +3.3% | +1.0% |
| Canada TSE | 15193 | +6.0% | +11.5% |
| Swiss SMI | 8611 | +1.9% | +5.0% |
| Commodities | Chg vs End-1Q | Chg vs End-2013 | |
| Oil, $ per barrel | 104.69 | +3.1% | +6.4% |
| Gold, $ per ounce | 1328.60 | +3.5% | +10.5% |
Copyright Larry Greenberg 2014. All rights reserved. No secondary distribution without express permission.
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