Currency Thoughts

Weekly Foreign Exchange Insights: December 12th

December 12, 2008

The holiday season, such as it is in this year to forget, will envelop currency trading next week. The dollar falls more times than not in the second half of December and approaches this one with a distinctly offered tone. Fourth-quarter dollar highs were reached in October against the yen, euro, Canadian dollar, and Australian dollar. Quarterly highs against the Swiss franc and New Zealand kiwi occurred last month, and even woeful sterling has recovered 3.1% since bottoming out against the U.S. currency on December 4th.

At today’s high of 88.40 per dollar, the yen showed a year-to-date advance of 26% and was at its best level since the summer of 1995. The euro and Canadian dollar outperformed other currencies this past week, climbing around 5% against the dollar, roughly twice as much as the yen and the Australian and New Zealand dollars. The euro has appreciated slightly more than 3% against sterling this week and by about 1.5% against the Swiss franc. At the euro’s high against sterling of 0.8944 earlier today, the pound’s translation value against the synthetic D-mark was at 2.187, just over 1.1% above its all-time low of DM 2.1640 in November 1995. That historic trough corresponds to a euro per pound value of 0.9038, a barrier that is very likely to get breached before yearend.

The dollar’s recent losses do not detract from the fact that 2008 was a very good and unexpectedly respectable year. There have been year-to-date advances of at least 25% against sterling and several commodity-sensitive currencies (Canadian, New Zealand, and Australian dollars, for instance). The dollar retains a 9% net rebound against the euro and is 20% stronger than its record low of 1.6038 hit last July. Several developing currencies plunged against the dollar in 2008, and the Chinese yuan stopped appreciating against it around midyear. Compared to end-2007, the trade-weighted dollar is up about 10%. By comparison, trade-weighted indices of sterling and the Canadian dollar each fell about 19%, the trade-weighted yen soared 30%, and the trade-weighted euro was an island of stability with a net drop of merely 1.4% so far.

The dollar’s softer recent tone does not reflect any apparent shift in economic fundamentals. Virtually no economies have not been severely affected by a global recession. Equities, bond yields, and commodities have plunged, inflation is receding very quickly, and macroeconomic policies have been extensively loosened almost everywhere. Various forms of quantitative monetary easing either are being or will be employed. The Bank of Japan and Fed hold their final policy meetings of 2008 next week. The BOJ target is at 0.3%, and officials are resisting further cuts in such. The Federal funds rate of 1.0% will be slashed to 0.5% or even 0.25% but will not really exert much influence on the economy. The emergence of a tepid recovery in the second half of 2009 remains more of a wish than a forecast that can be defended with strong conviction. The U.S. budget deficit seems headed toward around 9% of GDP, well above its greatest relative size in the 1980’s or Vietnam War era. Auto industry experts by and large believe the GM will not be allowed to go into bankruptcy later this month even if the Congress fails to reach an accord. It’s easy to be sympathetic with opponents of a bailout for the same reason that not bailing out Lehman Brothers seemed at the time to be a proper exercise of tough love. In retrospect, letting Lehman fail produced more damaging fallout than anyone foresaw.

While I am bearish about the dollar in the long term, I doubt that the auto industry drama is what’s turned the dollar back down. Currency markets this year have not marched to the beat of economic data, changing interest rate spreads, or either short-term or long-term prospects for the U.S. economy and its main rivals. The dollar and the yen to an even greater degree benefited from liquidating markets, including the unwinding of carry trades, against the backdrop of profound risk aversion. Investors bought dollars as a natural bi-product of asset sales made under duress. 2008 made famous the expression that people are seeking a return of investment, not a return on investment, and Treasury debt offered the quintessential vehicle for satisfying such logic. The metrics that dominated markets in 2008 and which among other results pushed the dollar higher remain in place. One interesting development to note, however, was that U.S. stock prices lost ground for the week, whereas equities rose solidly in Europe and Japan.

Until a more enlightening factor emerges to explain why the dollar did so well in 2008 but has reverted to a more fragile looking asset late in the year, seasonal patterns offer a tempting reason. If seasonality lies behind the lower dollar, the softness is apt to persist a while longer. There was a time early in the dollar-floating era when the second half of December exhibited the most powerful and consistent seasonal bias. The greenback declined against the mark during those roughly two weeks in 13 of the 14 years to 1987, with an average depreciation of 1.7%. For a while thereafter, the bias went away. From 1988 through and including 2001, there were an equal number of years in which the dollar rose or fell against Europe’s main currency, the mark initially and then the euro, between December 15th and yearend. For those fourteen years, the dollar on average posted a dip of just 0.4%. More recently, the late December tendency toward depreciation has returned, with declines against the euro in five of the last six years and an average drop over the period of 1.1%. Frequently, early January then saw the dollar turn for the better.

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This entry was posted on Friday, December 12th, 2008 at 5:13 pm and is filed under Foreign Exchange Insights and Next Week. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.