Weekly Foreign Exchange Insights: February 13th

February 13, 2009

Intra- and inter-day volatility, random noise if you will, has eclipsed any element of sustained currency market trend during the past five weeks.  The dollar has traded widely within high-low ranges of 18.8% against the New Zealand kiwi, 12.2% against sterling, 12.1% against the Australian dollar, 7.5% against the Canadian dollar and almost identical bands of 6.1% against the Swiss franc and 6.0% against both the yen and euro.  However, the dollar has also traded with a notion of equilibrium to which it returns after straying too far away.  If this pattern continues in the short run as I would expect, an effective trading strategy will be to continue selling dollars at levels above its central tendency and to buy them back at weaker-than-central levels.

  • Dollar/yen straddled the 90 level in four of the past five calendar weeks including February 9-13.
  • EUR/USD straddled 1.30 in three of the past five weeks including the most recent one.  One week saw a 1.2.. handle at all times, and the range was exclusively 1.3-something in the remaining week.
  • The dollar has straddled 1.16 Swiss francs in each of the last three weeks.
  • The table below of weekly high-low range midpoints in the U.S. dollar against commodity-sensitive currencies documents a tight center of gravity for those pairs as well:
Week of: C-dollar A-dollar Kiwi
January 16 1.2274 0.6771 0.5590
January 23 1.2570 0.6631 0.5357
January 30 1.2222 0.6539 0.5211
February 6 1.2381 0.6525 0.5165
February 13 1.2341 0.6641 0.5293


The first eighth of 2009 is over, and the dollar retains across-the-board gains made in early January.  At 16:30 GMT today, the dollar showed moderate and similar advances from end-2008 of 2.2%, 1.4% and 1.3% against the Canadian, British and Japanese currencies.  Significantly greater ground had been captured against the kiwi (11.3%), euro (8.6%), Swiss franc (8.3%) and Australian dollar (7.5%).  Only 3-1/2 calendar quarters remain in a decade that will be remembered for terrorism and a boom-bust global economic cycle.

The dollar and yen continue to be correlated positively with the give-and-take of risk aversion.  The instability of risk aversion, up one moment on doubts about government policies but down the next when officials conjure up additional schemes, is the reason why the dollar is oscillating back and forth rather than moving along a directional trend.  It will be a quarters or years, not months, before a definitive sense of the effectiveness of policy efforts can be firmly grasped.  The ebb and flow of investor risk aversion is going to remain a fact of market life for quite a while.  That does not rule out the resurgence of a trend factors to dominate random noise, but such a transformation seems unlikely in the near term.

G-7 officials do not want to be perceived as an non-cohesive  group bent on conducting policies that promote one’s own national economic interest at the expense of another’s.  This does not mean that protectionist strategies will not be implemented, but it does diminish the risk of verbal or actual intervention to depreciate one’s own currency.  For the record, the watchword goal is going to be currency stability and the avoidance of disorderly and sudden movements that do not reflect fundamental economic conditions.  Part of the tug-of-war in dollar/yen around the 90 level reflects the perception that officials in Tokyo and Washington secretly would like to see their own currency weaker than that level.  But nobody wants to risk currency wars like those in 1987, which created conditions for the global stock market crash in October of that year.

Euroland officials face a bigger threat.  The emergence of widening long-term interest rate spreads among the bloc’s members has fanned speculation that one or more participants might pull out of the arrangement.  The euro’s birth was accompanied by considerable skepticism that currency union without a single fiscal policy would hold together.  Such worries melted with time as the arrangement flourished and in the face of huge perceived and mounting disadvantages for any government trying to pull out.  Moreover, the Stability and Growth Pact, which was meant to enforce fiscal convergence and discipline, turned out to be an empty deterrent.  Most importantly, Euroland’s economy expanded for most of this decade, so there was no stress test for the euro until now.  With the going getting tough, cynics worry that the not-so-tough nations might bail out.  These concerns provide a near-term incentive for third-party governments to think twice before diversifying reserve asset portfolios from the dollar to a heavier weight in euros.

Gauging the relative severity of the recession among major regions is not a straight-forward exercise, because recessions are not measured by a single criterion  The U.S. labor market has suffered more acutely than others, losing 1.77 million jobs in the last three reported months and 3.57 million jobs since end-2007.  The NBER correctly back-dated the recession’s onset to end-2007 despite rising GDP in the first half of last year.  Europe’s GDP contraction was much more severe than America’s last quarter both in Euroland and Britain, and Japan’s figures due Monday will be even more horrific than the European numbers.  It may be tempting to conclude that a more rapid U.S. policy response and more flexible labor market will translate into an early and sturdier recovery.  Such logic was heard frequently in early January when as justification for the rising dollar, but the thinking is overly simplistic.  Job layoffs and the lack of hiring could hammer U.S. personal consumption going forward, neutralizing progress made recently in shedding inventories and wage costs.  Also, the U.S. housing sector must stabilize before one can confidently look to recovery, and the economy’s responsiveness to macroeconomic support and the financial system rescue efforts remains unsure.  Finally, dollar appreciation from its 2007-2008 lows will constrain net exports.

From the standpoint of currency prospects, possible discrepancies in future macroeconomic trends remain very uncertain and not a reliable basis for forecasting trend.  Interest rate differentials are also a poor guide, being no longer wide — less than 75 basis points for three-month U.S. versus euro deposits, for example.  Shifts in market risk aversion are likely to be the key driver in the short run.  The approaching Japanese fiscal yearend at end-March is already being mentioned in market chatter.  For February-March, the view that capital repatriations will boost the yen has been generally over-rated in past years.  A bigger upward bias in the yen has
been observed to occur in April than the two previous months.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.


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