Different Directions So Far in February

February 17, 2015

In this winter of discontent, Greek debt talks are commanding keen attention, but eurozone members, who presumably are susceptible to the forces of contagion have remained surprisingly insulated from market tension.  The ECB’s 20-month-long purchase of EUR 60 billion of assets launches next month, and the Swedish Riksbank is the most recent monetary authority to adopt a negative nominal interest rate.  A third-quarter timetable for the first Federal Reserve interest rate hike remains likely.  Japan’s recession appears over, but the fourth-quarter growth was weaker than assumed.  Britain’s spring election is approaching, and ongoing acts of terrorism and unusual weather patterns are lending an ominous tone to the daily news. 

Some of the most interesting developments this month, however, involve market direction.  The dollar, which hasn’t posted an end-month to end-month decline against the euro since mid-2014, so far shows a slide of nearly 1% against the common European currency.  Dollar/yen fell in January for the first time since last June but has this month recouped most of last month’s slide.  The ten-year Treasury yield, which slightly more than a percentage point between the end of the third quarter and end-January including a down-move of 43 basis points last month, has reversed all of January’s drop so far in February.  Long-term sovereign debt yields have risen in other countries this month, too, but by not nearly as much as in the United States.  Oil has rebounded more than 6% in February after having lost about half its value between mid-2014 and end-January.  West Texas Intermediate crude fell by at least 2% in every one of seven successive months and by over 7% in five of them.  Some pundits think the recent respite is just a short interlude on the way to potentially much lower levels, while other believe that a very choppy equilibrium may now be at hand.  Gold has been yo-yoing between $1,200 and $1,300 an ounce.  January saw the yellow metal climb 8%, while it has fallen back over 5% more recently.

After a span of market volatility as experienced since mid-2014, it can be difficult to discern cause from effect.  Some analysts are arguing that oil is falling in part because of a stronger dollar, but I believe directionality is just the reverse.  The euro’s response if Greece careens away from the single currency is still unclear.  A resurrected drackma surely would depreciate very sharply, much as currencies have done after leaving previous joint European floating arrangements.  It’s also true that the euro would be much stronger now against the dollar had Greece never participated — all the more so if some of the other perceived weak links had also never joined, but that’s not the same experiment as a single currency facing diminishing membership. 

An entirely different but very influential consideration involves the lagged economic repercussions of dollar appreciation that has recently occurred.  Weakening net foreign demand depressed U.S. GDP growth by a trivial 0.2 percentage points (ppts) in 2014 but a much more meaningful 1.0 ppt annualized in the final quarter of the year.  Between 4Q13 and 4Q14, real import growth of 5.3% was more than twice as great as the rise of exported goods and services.  Euroland’s trade surplus widened 28% last year, and Japanese exports in December 2014 were marginally more than 19% greater than in the final month of 2013.  But 500-pound gorilla in the room of trade representatives is China’s ballooning trade surplus.  It surged to a record $60.03 billion last month from monthly averages of $49.8 billion in 4Q14, $42.7 billion in 3Q, $28.7 billion in 2Q and $5.5 billion in 1Q.  Accusations of yuan manipulation by Beijing are bound to be voiced more forcefully later this year.  That will curb buy-dollar speculation even if no concrete policy counter-punches result, and it may create second-guessing about the timing for the first increase in  the fed funds rate and the path of subsequent tightenings.

It seems unlikely that dollar appreciation against the euro has run its full course.  However the talks over Greece’s financial bailout get resolved, the unsynchronized ECB and Fed policy cycles ought to see the dollar work further upward.  Similar prospects seem likely to await dollar/yen.  Those two dollar relationships don’t move in lockstep.  It’s in fact unusual that they shared the same direction in the final five months of 2014.  The streak was broken in January, and the signs of their movements so far this month are also dissimilar.  But February has been different from January for each of them, and over a span of several months, the most likely scenario is that they will have each lost some ground to the U.S. currency.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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