Weekly Foreign Exchange Insights: April 17th

April 17, 2009

Some foreign exchange market trends during the financial market crisis make considerable sense, like the losses of commodity-sensitive currencies such as the rand, Australian dollar, New Zealand kiwi, and Canadian dollar or the currency troubles of numerous overly indebted East European economies.  Other developments have not been especially intuitive.  The strongest and weakest G-7 currencies since the crisis began on August 8, 2007, respectively the yen and sterling, belong to especially hard-hit economies.  Over the entire span of the crisis, the dollar has appreciated 36.7% against the pound but dropped 16.5% versus the yen.  At no time is expected relative economic growth an entirely reliable guide to currency performance.  The correlation has been even more tenuous since financial markets began to misfire.

The euro and Swiss franc have weakened around 3% during the past fortnight.  Swiss officials strongly wish to prevent any further franc appreciation against the euro and will undertake intervention and possibly other steps to ensure that their currency keeps moving pretty much in tandem with the euro.  The common European currency is around 9% weaker than its value at the start of the financial crisis, and roughly three-fourths of that erosion occurred so far in 2009.  The euro nonetheless remains more than 11% above its birth weight of $1.1720 at the end of 1998.  That level holds special technical significance because it is not only the euro’s opening level but also because it nearly matches the euro’s lifetime average level (that is, the mean since end-1998) of $1.1595. A similar coincidence is that the Swiss franc’s dollar value at end-1998 of 1.3730/USD is also almost identical to its average since end-1998 of 1.3740/USD.  By sheer luck, when European Monetary Union began slightly more than ten years ago, no significant misalignment existed against the dollar, and the same thing can be said about the Swiss franc.

Several factors are now weighing on sentiment toward the euro.  Markets dislike when a central bank’s policymakers disagree in public, as members of the ECB’s 22-person Governing Council have been doing.  Some differences are to be expected in present rare economic circumstances, as central bankers contemplate unconventional and untested actions and in light of the large number of policymakers and wide range of economic trends in the sixteen nations they represent.  Minutes from the FOMC minutes indicated various viewpoints, and the Bank of England has a well-worn record of dissenting opinions.  What stands apart at the ECB is that disputes are usually kept out of public sight, a tendency that is promoted because that Bank does not publish minutes from its meetings or reveal individual voting records.  Euroland is expected to report weaker growth than the United States in 2Q09, 2H09 and next year, and its current account has deteriorated in contrast to the improving trend of the U.S. balance of payments.  The euro’s immediate challenge involves whether it finds support at $1.30, a level not breached since the week to March 20th and beyond that whether its 2009 low of $1.2459 is tested this quarter.

Sterling was everybody’s favorite currency to disparage not long ago, and the New York Times ran an article this past week comparing the gloomy current mood in Britain to 1976, when sterling fell  over 23% to $1.5550 by October after sinking under $2.00 for the first time in early March.  Britain’s fiscal deficit in 2009 will exceed 11%  of GDP, more than twice as much as then, and the current account shortfall is also relatively larger now.  The 1976 debacle culminated in Britain going to the IMF for aid, and the country was ruled by an increasingly unpopular Labour Party government as it is also now.  But after huge losses in the second half of 2008, sterling shows a drop of less than 2% against the dollar so far this year, and it has basically matched the dollar’s sharp advances against the euro and Swissy over the last fortnight.  Will the euro be the next sterling, a currency that gains surprising stability after being widely given up for dead?   The contrarian reputation of foreign exchange trading is well earned and often reinforced.

Dollar/yen pivoted the psychologically important Y 100 level in each of the last three weeks, but movement over a somewhat longer time frame going back to mid-February favored yen strength.  The yen has not been weaker than 101.5 per dollar but has a defined upper boundary in that period of 90/$.  The more confident investors become about a coming U.S. recovery, which is widely believed to be a necessary condition for economic stability elsewhere, the less risk averse they are apt to become.  Recurring risk aversion has kept the yen more often than not on the strong side of 100.  A more confident marketplace would permit the yen’s center of gravity to shift to the soft side of 100/USD.  So too would a return to deflation in Japan.  The yen performed weakly during the earlier period of negative on-year Japanese consumer price inflation.

In the spirit of G-20 cooperation, the U.S. Treasury again failed to cite China for currency manipulation in this past week’s semi-annual Report on International Economic and Exchange Rate Policies.  While restating the belief that the yuan remains undervalued, the Treasury Report strikes a more favorable tone toward Beijing than the last Bush Administration report or comments by then candidate Obama and his Treasury Secretary Geithner last January.  Declining Chinese reserves and the yuan’s sharp gains against other currencies are mentioned in the document.  This report gives Beijing a pass to continue pursing a fixed parity against the dollar, and other governments will not complain if that translates into a continuing upward creep of the yuan against their own currencies.  This suggests that currency market intervention, either unilateral or collective, has become a less plausible prospect.  Nobody wants to be accused of beggar-thy-neighbor currency policies at a time of shrinking global trade and GDP. 

The administration’s flip-flop on China’s currency also illustrates an important stylistic shift from the preference during the Bush years for consistency over correctness.  In an uncertain landscape, convictions are rarely absolute, and a key shift in policy may be one surprising fact away.  If market players find the policy framework to be too loosey goosey, they may take it out on the dollar in time.  So far, that hasn’t happened.

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


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