Is the Dollar Uptrend Over or Merely in a Pause?
April 9, 2015
It’s difficult to gauge momentum behind the dollar’s uptrend by focusing upon bilateral currency relationships. Market-determined currencies like the euro, yen, Swissie, sterling and Australian, Canadian and New Zealand dollars have not moved in lockstep since the dollar’s current rally began about eleven months ago, nor have the cumulative swings in the dollar against each been of roughly equal size. Net gains against the yen and kiwi topped off in early December. In contrast, half the appreciation against the euro happened in the ensuing three months, and the path of the trade-weighted dollar has more closely paralleled the common European currency than the yen. Abstracting from the individual paths taken by the dollar’s bilateral relationships, one is left with two elements of the big picture. First, the dollar’s advance since May 2014 has encompassed most other currencies, and secondly, the uptrend has flattened during the most recent month. It’s fair to ask if the movement has essentially run its course, and the weight of fundamental economic developments and prospects suggests that it is not.
For one thing, currency market equilibrium tends to be defined by a direction rather than a single price. Fundamental economic conditions in a relative sense being the same, the dollar is most likely to remain along the vector it’s been traveling. The swing can be reversed by policy changes designed explicitly to halt the trend or by shifting economic fundamentals, the gestalt of which shifts significantly between dollar-supportive and dollar-negative. Put in more simple terms, currency movements have an intrinsic tendency to overshoot, so the forecasting burden of proof always lies with making the case that things are changing in an undeniable way. It doesn’t seem that that has happened.
The paused dollar uptrend since around mid-March has been fed mostly by concerns that U.S. growth may have slowed. This is related to data noise, however. U.S. growth has in fact been remarkably steady as attested by sequential calendar year rises in real GDP of 2.3% in 2012, 2.2% in 2013 and 2.4% in 2014. While below growth that used to be the norm for the United States, GDP expansion of only slightly more than 2.0% is quite a bit faster than what Japan and Europe have experiencing. The U.S. has commanded a growth advantage since the dollar uptrend began, but it also rose faster than other economies when the dollar was falling. Faster growth per se doesn’t answer the question of whether the dollar is likely to rise or fall.
Differences in monetary policy cycles, in contrast, are an important driver of dollar movement. Whether the federal funds rate is raised in June, July, September or even later than September, U.S. monetary policy is transforming from more to less accommodation and has been doing so since QE tapering began. The last changes in ECB policy last month and BOJ policy last October generated more accommodation, and those central banks will not start reining in stimulus for at least another year and probably longer.
The U.S. balance of payments does not pose a problem to the dollar. The current account deficit equaled an easily manageable 2.4% of GDP in both 2013 and 2014, and February’s goods and services trade deficit of $35.4 billion was the smallest shortfall in more than two years. A political imperative to halt dollar appreciation is well below the level it needs to reach before either unilateral or concerted policy action will be taken to reverse the trend. To be sure, the FOMC minutes cited dollar strength as one factor that might affect the timing of a rate hike and subsequent normalizations of policy, but that’s different from any thought of engaging in currency warfare.
On inflation, too, the U.S. is in an enviable position. Inflation is lower than what the Fed is targeting, but the danger of falling into deflation is much lower in the States than many other economies. To the extent that U.S. long-term interest rates are well below what one might expect six years into an economic recovery both in nominal and real terms, it is because of the even lower sovereign debt levels found elsewhere. One or two hikes in the federal funds rate are not likely to boost long-term rates much more sharply as happened from the trough of earlier business cycles, and that limits the downside risk to U.S. equities.
The United States doesn’t have an immediate fiscal problem. Calm in that area contrasts with Japan’s record debt-GDP ratio and with Europe’s game of chicken over Greek debt that could inflict big damage on banks in the region. The U.S. has made huge strides toward energy independence and has better demographic properties than other advanced economies.
Most likely, the dollar uptrend is merely pausing for breath. An uneven appreciation against other major currencies will likely resume, putting parity with the euro on the radar screen and taking the yen to new cyclical lows.
Copyright 2015, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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