Weekly Foreign Exchange Insights: January 16th

January 16, 2009

In the present deflationary economic context, it is better to have a weak exchange rate.  One of the lessons from the 1930’s depression was that having a weakening currency early in the experience seemed to soften the blow.  Officials, who speak cavalierly about their currencies, are being smart, not reckless.  The start of a new chapter in U.S. government offers an excellent opportunity for launching a soft dollar currency.  Many new administrations before have done such to stimulate exports and found the price to be not worth it.  This time would be different.  U.S. policy has already shifted: the mantra about a strong dollar being in America’s best interests is no longer heard.

Officials in other governments are already promoting softer currencies.  China stopped appreciating the yuan in mid-2008.  Russia is front-loading a downward adjustment of the rouble, which has already fallen to levels not expected until the final quarter of the year.  Turkey’s central bank slashed rates by 200 basis points yesterday, double the amount that was expected and essentially daring the market to sell the vulnerable lira.  The Mexican peso has lost almost 3% this year and has sunk 23% over the past twelve months.  A top Swiss National Bank official this week claimed mounting concern that the franc is getting too dear.  Every country cannot depreciate its currency at the same time, so only the early birds are likely to reap rewards.  The Obama administration faces an uphill task.  The dollar and yen were the strongest major currencies this past week and have risen against the euro by 21% and 41%, respectively, from lows set last July.

Commodity prices are still falling, led by an additional 10% drop in oil prices this week.  Oil prices are 75% below their peak last July.  Commodity-sensitive currencies also suffered big losses in the second week of January.  The dollar as of 15:00 GMT today had advanced 8.3% against the New Zealand kiwi and by over 4.0% against the Australian and Canadian dollars.  Depreciation will not deter the Bank of Canada from cutting its target rate at least 50 basis points next Tuesday to 1.5% or prevent the down-under central banks from easing when they meet next.

The recession is truly global and extraordinarily severe.  I’m struck by the profound weakness of economic data released this past week.  The figures were for  last year, but forward-looking European PMI readings due next week will be consistent with the present quarter being at least as depressed as the last one.  Meanwhile, highlights of this past week’s releases stretched comprehension, and central bank officials from ECB President Trichet to BoJ Governor Shirakawa to BoE Deputy Governor Gieve warned of accelerating downturns and nastier financing conditions for corporations.

  • Exports recorded monthly declines in November of 17.4% in Japan, 6.8% in Canada, 5.8% in the United States and United Kingdom, and 4.7% in Euroland.
  • Euroland industrial production plunged 19% at an annual rate between August and November. U.S. industrial output fell 11.5% at an annual rate in 4Q08.
  • Japanese core domestic machinery orders fell 27.7% in the year to November, while foreign orders dropped 44%.
  • Japan’s Economy Watchers’ index dropped to 15.9 in December from 21.0 in November and 28.0 at end-3Q08.
  • Officials warned that 4Q08 growth in Germany and France could be as negative as 8% and 6.5%, expressed in annualized terms.
  • Full-time workers in Australia dropped 43,900 last month, and the jobless rate climbed to a 21-month high, also suggesting an imminent recession.
  • U.S. retail sales fell 28% at an annualized rate between September and December.
  • Chinese growth in 2007 was revised up to 13%. A drop to 7% or less in the year to 4Q08 will constitute one the the largest downshifts anywhere.
  • The bounce in share prices between November 20 and January 2nd was a flash in the pan.  As of 16:40 GMT, losses this week totaled 8.5% on the German Dax, 6.9% for the Japanese Nikkei, 6.4% for the British Ftse, and 4.3% in the Dow Jones Industrials. The DOW this past Wednesday passed another anniversary of its January 14, 2000 bull run peak.  That index dropped 3.9% per annum over the ensuing nine years.

For most governments with flexible interest rate regimes, manipulating currency values when all nations are in a similar sinking economic boat is not easy.  Intervention would look blatantly predatory.  Scope is diminishing in most countries for cutting interest rates.  Verbal rhetoric becomes the preferred tool, but a comment about currency values, such as that by the Swiss central bank official this past week, is likely to be drowned out by the flood of policy initiatives and closely-watched economic and corporate news.  Even if a will emerges to depreciate the dollar, the practical difficulty of finding an effective means to promote such will present a continuing hurdle.  Inflating debt away is one possibility, but price risks during 2009 will be skewed to the downside, not upside.  Moreover, other governments are also pursuing policy that would lift inflation in normal times.

The dollar’s buoyancy is not corroborated in net capital flows reported by the U.S. Treasury.  All three definitions of net capital movements showed a substantial deterioration between October and November, and the two definitions that exclude short-term capital (definitions #1 and #2) were much less supportive on average in August-November than in full-2007 or full-2006.  Figures below are expressed in billions of dollars and on a per month basis.

$ blns Nov Oct Aug – Nov 2007 2006
Def’n #1 -21.7 -0.4 -14.5 +64.7 +74.4
Def’n #2 -33.7 -15.2 +1.2 +45.1 +59.8
Defn #3 +56.8 +260.6 +119.2 +51.4 +88.5


From the vantage point of mid-January, dollar weakness in late December looks seasonal, which was as I suspected it would be.  A seasonal pattern of softness in the second half of December followed by recovery in the first half of January has occurred frequently and explains much of the movement of the last 30 days.  But if market dynamics now revert to what dominated prior to mid-December, the main factor should be risk aversion.  That environment lends support to the dollar and yen, but Japanese and U.S. officials ought to be worried if any additional appreciation occurs. 
The problem remains, how do they stop irresistible market forces?  It would be like fighting against mother nature.  Put differently, the challenge is finding ways to harness capital flows, which as the table reveals swing wildly from month to month or even moment to moment. 


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