Dollar Corrections Past and Present
June 16, 2015
I learned much about the interplay of market trends and temporary corrections within those trends from the dollar’s behavior between 1980 and 1985. My entire experience as a dollar watcher had been consistent more or less from the two devaluations while I attended graduate school through my ensuing career at the New York Federal Reserve. The dollar weakened most of the time especially against a trio of hard currencies, the Deutsche mark, the yen and the Swiss franc. But the long periods of depreciation were occasionally punctured by comparatively short spikes of strength such as one I observed during my first stint in the Foreign Department during 1975.
The dollar’s weakness in the 1970s made considerable sense to economists watching fundamental economic trends. The United States had some glaring weaknesses. Whether measured against U.S. historical norms or contemporaneously against hard currency country performances, the United States experienced high inflation, a chronically excessive current account deficit, and a predisposition by monetary policymakers for low real interest rates.
After a decade of fundamentally driven dollar depreciation, expectations of that kind of landscape continuing were very entrenched by the time the 1980s rolled around even after former Federal Reserve Chairman adopted a monetarist strategy of quantitative tightening in October 1979. The stars after that dramatic policy shift were better aligned for the dollar, but the thought was inconceivable of a multi-year appreciation ultimately doubling the currency’s external value. Like other financial markets, prolonged currency movements inevitably suffer setbacks, and there were three big ones in the dollar during the early 1980s. Because of a hard-wired view of long-term dollar weakness, these corrections within the upward trend tended to be seized upon by analysts as an end to the dollar’s run and resumption of the long-term slide.
The three corrections in the dollar in the 1980s exhibited amazingly consistent properties. Consider the dollar/mark relationship, which back then held the importance now afforded to the EUR/USD pair. After climbing 48% over twelve months, the dollar began falling in mid-August 1981 and tumbled some 15% within a short three-month span. That correction ended, and the dollar recovered 18% over the ensuing year, only to suffer a second correction commencing with news that Soviet General Secretary Leonid Brezhnev’s death in November 1982. A center-right government led by Helmut Kohl had shortly before come to power without election in Germany, and the Federal Reserve had begun reducing interest rates as the U.S. entered its second year of recession. An election in Germany to enhance the mandate and legitimacy of the new conservatively-minded government was planned for early March 1983, and the end of the dollar’s revival seemed even more assured than had been so at the time of the 1981 correction. But after tumbling 10% in just two months, the dollar reversed course even before the German election and kept rising when voters indeed ratified the shift in government. For yet another year, the dollar climbed again, this time rising 22% against the mark. When a third downward correction in early 1984 struck, one could be tempted to think this drop would endure in light of a deteriorating U.S. current account outlook.
However, being mindful of the two false rallies in the mark, the currency market forecasting team at Chemical Bank on which I worked introduced a strong technical element into the projection. Noticing that the corrections had been steep in magnitude but brief in duration, we decided to retain a strong dollar outlook unless the correction surpassed four months, and that failed to happen. After dropping 11% in two months, the dollar’s upward course resumed and in fact became increasingly speculative, boosting the dollar by 38% to DEM 3.378 by late February 1985 when yet a fourth significant interruption to trend began. Again, we agreed not to bail on the dollar until and unless it was still declining four months into the run. This time that did happen, and the forecast was changed well before the G5 Plaza Summit Accord of September 22, 1985. The dollar’s long-term descent carried through 1986 and 1987.
The 1980s experience demonstrated that duration can be more important than steepness or cumulative movement in distinguishing a true turning point in trend from a transitory correction imbedded within the trend. A second lesson is to pay very close attention when fundamental news fails to elicit the market reaction one might normally expect. The mark’s non-response to the German election of March 1983 told volumes more to foreign exchange market participants than the election’s specific results. In the period ahead, one would expect a Greek default or abandonment of the euro to hurt the common currency. And if the Fed now sends signals that a rate hike may not happen even by September, common sense would point to lessening dollar strength.
The dollar in fact is presently in what could be construed as a correction. At hasn’t set new highs against the euro, Canadian dollar or Swiss franc since mid-March. From 1.0459 per euro on March 16 to 1.1467 on May 15, it fell 8.8% and currently stands just 2.1% from the May low. The Swissy rebounded 11.1% between March 18 and May 14, and the Canadian dollar recovered 7.7% from March 18 to May 14. Those currencies are similarly just a couple of percentage points from their May highs. Dollar/yen has followed a somewhat different path, hitting its strongest level of 2015 earlier this month and still lying within 1% of that level.
Sterling’s profile and those of the Australian and New Zealand dollars are also somewhat different from the euro, Swiss franc and Canadian dollar. The U.S. dollar fell 6.7% against the Aussie dollar between April 2 and May 14, only a little less than corrections against the pound, loonie and euro but then recouped almost all of that loss rather than less than half. In the kiwi’s case, the U.S. dollar dropped 4.5% from a high on April 1 but subsequently recouped all that ground and then some. In the example of sterling, the dollar’s drop of 7.7% between April 13, and May 14 is of similar magnitude to other corrections, but in contrast to the kiwi in particular, the dollar remains very near its low.
EUR/USD is the main relationship to watch for clues to whether the stalled dollar uptrend will be a correction or a trend change. Exactly three months have passed since the dollar touched its high for the move against the common European currency, that being $1.0459. The correction since that peak is less than a typical size but may yet widen to 10% or more. Within another month or so, most corrections would have petered out, and market participants should have a much better idea about the dollar’s likely direction during the second half of 2015.
Copyright 2015, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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