Foreign Exchange Insights
July 11, 2008
Among the major currencies, the euro benefits most from eroded confidence in the dollar, and the Australian dollar gets the greatest boost from commodity price inflation. The euro at $1.5946 climbed within 0.5% of its record high today, and the Australian dollar hit a new peak for the move of $0.9717. At this morning’s best levels, by comparison, the yen, kiwi, Swiss franc, Canadian dollar and sterling remained below their 2008 highs by 9.4%, 6.9%, 5.0%, 3.5% and 2.3% respectively. Investors are caught in a minefield of event shocks related to possible war between Iran and Israel, mounting credit loss shocks, a broadening global slowdown, and inflation expectations that are unraveling.
- Bin Laden asserted in 1998 that the real price of oil ought to be $144 per barrel. He’s achieved his nominal strike price, but a $144 real price in 1998 is now equivalent to a nominal price of $190/barrel. The war he provoked with the West was only a military means toward his objective of declining economic empowerment for the United States and its allies. Progress in the war on terrorism should be measured not by what happens on the battlefield but by what happens to oil prices and the damage that their rise is doing to Western economies. Oil and other commodities swung widely last week but were 2.1% higher on balance toward mid-day in New York on Friday. The United States is an addicted oil importer and user, and it is the focus of the power shift toward all emerging nations and from oil consumers to oil producers. Investors see dollar depreciation and commodity price appreciation as intertwined cause-and-effect drivers of one another.
- The dollar fell last week against most currencies despite safe haven demand for Treasurys from credit loss risks, and press reports that Freddie Mac and Fannie Mae might be taken over by the government did not keep the dollar from sinking to its lows of the week on Friday.
- The U.S. economy is very weak outside of net exports, which appear likely to contribute more than 1 percentage point of GDP growth in 2Q08. A soft U.S. economy is not a new theme. What is new is that the economies of non-China Asia and Europe are deteriorating at a more rapid and unexpected pace. That surprising development led many analysts to declare the dollar’s downtrend over. It hasn’t happened. The $1.60 per euro level has offered formidable resistance to the euro, but it never backed off far from this barrier. After a depreciation that has been as prolonged as the dollar’s present one, it is more typical to see a definitive reversal (a “V”, not a “U”).
- As bad as growth prospects seem, central bank policy priorities have shifted toward containing an incipient rise in expected inflation and a major advance in actual inflation. All monetary authorities have attacked the problem verbally, but some have not backed their words with higher interest rates. The Federal Reserve in conspicuously one of those central banks.
The dollar fell in the week of the annual summit of G7 leaders. On a range of issues — Africa, the climate, oil, and currency management — the summit underscored the perception that the G7 is impotent. The dollar is weak, and officials cannot coordinate any initiatives to change that.
The week to July 18th will be packed with economic news and central bank attention-getters. Many releases of price data are scheduled: the U.S. CPI and PPI, Euroland, German, French, and Italian consumer prices, the British PPI, CPI and labor costs, and China’s CPI, PPI and money stock growth. Upcoming measures of activity encompass Japan’s tertiary index, British unemployment, Canada’s monthly manufacturing index and wholesale sales, Chinese industrial production, retail sales and business investment, German and French business sentiment, Italian orders, and U.S. industrial production, retail sales, auto sales, and housing starts and permits. Euroland will release monthly trade figures, while the U.S. Treasury puts out its monthly report on capital inflows, which are so vital to supporting the dollar. The central banks of Canada and Japan make scheduled interest rate announcements on Tuesday and are expected to hold their benchmark rates steady at 3.0% and 0.5%, respectively. Canada’s central bank will update its April semi-annual monetary policy report, revising growth down and inflation up. Similar modifications — less growth and more inflation — will be conveyed in the Bank of Japan’s monthly economic report. Last but hardly least, Fed Chairman Bernanke presents his semi-annual testimony on the U.S. economy to Congress on Tuesday and Wednesday. It would be surprising if he is not quizzed on the dollar, since his Chatham speech on June 9 contained a detailed discussion of the linkage of dollar depreciation and rising inflation. Such digressions are rare for any U.S. officials and especially a Fed Chairman. I would expect Bernanke to be more circumspect on currency policy this time, referring to the G7’s formal policy. Other topics in the testimony that could move the dollar will be views on oil, inflation, growth, the health of the financial system, and whether he would endorse a second round of tax rebates.
Late last year and early in 2008, the common view for the United States and other developed economies was that 1H08 would be very weak but that 2H08 would see positive momentum return even if such is not reflected in average 2008 growth figures. Fast forward to now, and the outlook for the second half of 2008 sounds much like 1H08 forecast made six months ago. Soaring oil prices have been the main factor stalling a pickup in growth, and given the high degree of uncertainty about oil, the U.S. housing market, and the spread of weakness to Europe, Japan and many emerging markets, there is much more caution by private and public-sector forecasters about defining when the global economy might climb out of its rut. Weak global growth ahead of a U.S. election, whose result is uncertain, is not an auspicious backdrop for engineering a big and sustainable reversal of the dollar.
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Is the Fed going to stay in a holding pattern until the elections? The has been a lot of criticism of the Fed, they seem to be letting things ride on the tough calls. Will this continue until the next adminstration is in place?
Like any central bank, the Fed wants to avoid the appearance of customizing its actions to an election timetable. The bigger question is will the Fed figure out what it should do: hike to counter inflation or cut to counter weak growth?