The Euro, Yen and Peso

March 6, 2017

This coming Thursday, March 9th, will mark the eighth anniversary of the low point hit by U.S. stocks in the Great Recession. The DOW and S&P 500 closed that day at 6,547 and 677. The economy was reeling. 4.5 million jobs were destroyed in the half year through March 2009, a downward monthly pace of 749 thousand. Real GDP contracted an an annualized rate of 8.2% in the final quarter of 2008, followed by a further 5.4% annualized decline in the first quarter of 2009. In hindsight, investors correctly perceived that the onset of economic recovery, which occurred in mid-2009, was nearer than the dire economic trends seemed to suggest.

As a monumental bottom in equities, March 9, 2009 is a convenient base from which to compare post-recession financial market performances. The DOW and S&P are about 220% and 250% higher now than then. Equities in German and Japan have recovered similarly, gaining 224% and 273%, respectively. But the change in sovereign debt yields has been quite different, in contrast. At 2.50%, the ten-year Treasury yield is 37 basis points lower than eight years ago and very close to their 2.48% average yield over the entire period. Ten-year German bunds, by comparison, have a current yield of just 0.33%, 261 basis points than 2.94% on March 9, 2009. The change in the 10-year Japanese JGB yield from 1.30% to 0.06% has been 124 basis points. The current Japanese yield is also well below their eight-year average of 0.73%.

One might expect to find the dollar much stronger now than eight years ago in light of much higher relative U.S. long-term interest rates. Indeed, the dollar is presently 19.0% stronger against the euro and 15% dearer against the yen than levels at which it closed on March 9, 2009. The dollar is also 20.8% above its 8-year average level of 1.2789 per euro. The extreme quotes for EUR/USD in this period were $1.5144 on November 25, 2009 and $1.0341 on January 3rd of this year. Dollar/yen averaged 97.24 over the past eight years and touched extremes of 75.55 on October 31, 2011 and 125.86 on June 5, 2015.

One can reasonably surmise that President Trump does not want the dollar’s upward trajectory this decade to continue. That would undermine his desire to slash the U.S. trade deficit. Consistent with a lite-dollar stance, the U.S. currency’s strongest levels thus far in 2017 were hit during the first week of the year — 1.0341 per euro on January 2nd and JPY 118.61 on January 3rd. But something is going to have to give in the period ahead. Verbal disparagements against the dollar can ameliorate fundamentally based upward pressure only so far stemming from the mix of U.S. monetary tightening and continuing quantitative stimulus and negative interest rates at the European Central Bank and Bank of Japan.

The wild cards involve political uncertainties. There are a series of crucial elections in Europe, starting in the Netherlands next week, shifting to France  in April-May and winding up in Germany late in September. If the EU breaks apart, it will be exceedingly difficult to contain dollar strength against the euro. Acts of Russian aggression would also tend to hurt the euro. The yen likewise would react poorly to hostile acts by North Korea or if oil prices were to slide anew.

Candidate Trump in 2016 was so antagonistic about Mexico that the peso became to quintessential market barometer of the likelihood perceived by investors of him becoming president. Earlier this year, just two days ahead of the inaugural, the peso plumbed to a record low of 21.92 per dollar. Amid visible distractions faced by the Trump administration, the timetable of U.S. policy changes that would directly impact Mexico’s economy has become less clear. And with a 12% recovery aided in addition by the rebound of oil prices for this energy producer, the peso has unexpectedly emerged early in this year as the best trading emerging market currency.

Given the importance President Trump puts on matters of immigration and trade, it would probably take a major political shakeup in Washington to prevent negative peso news from returning to the fore.

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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