Foreign Exchange Insights: June 26th

June 26, 2009

It’s been an uneventful summer for the dollar’ two main relationships so far.  Net movement over the five weeks since the Memorial Day weekend amounts to a rise of 0.4% against the yen and a dip of 0.6% against the yen.  EUR/USD is pivoting $1.40 with a fairly symmetric range this past week of 1.4138 to 1.3827.  The yen remains in the upper half of the 90’s, consistently stronger now than the psychological 100 level but not substantially so.  The yen was confined between 96.57 and 95.01 in the latest week and between 98.58 and 94.43 over the past five weeks.

Next week envelopes the cusp between the second and third calendar quarters and the release of some critically important data in Europe, the United States, and Japan.  Some transactions will be inspired by accounting considerations, which could lend price action a choppy nature.  The U.S. observance of Independence Day on Friday and release of both unemployment insurance claims and the June labor force survey on Thursday may give the week a truncated feeling.  The typical  month-end barrage of Japanese figures will be augmented by the Bank of Japan’s quarterly Tankan corporate survey due Wednesday.  Europe will report key business and consumer confidence indices as well as retail sales.  PMI releases by many economies will give analysts another chance to decipher differences in how major regions are positioning for economic recovery.  Emerging Asia is leading that particular race, and Japan experienced a swing back to decent positive GDP expansion.  The United States also seems on track to record positive growth sooner than Europe.

Hope continues to build that individual economies and the world economy will avoid a double-dip recession.  Forecasts are getting revised up, not downward, as was the case before.  Even arch-bear Professor Roubini was heard voicing less pessimism.  My sense is that investor psychology would probably react more violently if information took a turn for the worse than if results prove even better than expected now.  I’m especially worried about the reaction if stock indices were to revisit March lows or fall much closer to them.

Stronger expected economic growth often does not correlate positively with currency performance, and that was the case this spring.  The dollar is about 10% weaker against the euro than on March 9 when U.S. stocks set lows and the economy seemed in free-fall.  Over those sixteen weeks, the U.S. currency has dropped over 15% against sterling and more than 20% against the kiwi and Australian dollar.  Having benefited from safety-seeking capital inflows last autumn and this past winter, the dollar has given back ground as investor panic simmered down subsequently.  The euro’s stalled rise around $1.40, however, may be signaling that the rise and fall of risk aversion may become a less influential determinant of currency movement.  When a round currency level like $1.4000/EUR presents repeated resistance against a prevailing foreign exchange trend, conditions ripen for a reversal of direction.

The summer of 2009 will be a politically active season.  Japan and Germany face elections at the end of the period.  The Liberal Democrats, who have ruled Japan for all but ten months since 1955 are in serious danger of losing power.   Chancellor Merkel of Germany is well-positioned, but German politics has been known before to shift unexpectedly once an election date moves into the near-future.  Tensions between Bank of England Governor King and British Prime Minister Brown keep rising.  And in the United States, President Obama is staking considerable political capital on his rush to get health care legislation approved by the August recess.  The president is also likely to announce a decision on whether he will reappoint Fed Chairman Bernanke or somebody new by early autumn, if not sooner. Currencies tend to be better bid if governments are presumed to be strong and stable, but the case of the United States in its current circumstances could become an exception to that rule.  Markets are nervous about the excessive U.S. Federal deficits and unconvinced that healthcare reform will alleviate long-term fiscal strains rather than adding to them.  It remains unproven whether the politics of the hour will allow the Fed to reverse monetary stimulus, and one can count on fiscal excesses and a steady diet of critical editorials in major business press to sustain market skepticism on the matter.  The ECB has an easier and less subjective task than the Fed, since the liquidity it has creased will expire automatically.  Governments in China and Russia are unlikely to put their calls for international monetary reform to rest until changes are made.

Foreign exchange history is full of examples to turning points around political elections.  Before 2007-9, the previously worst global economy occurred in the early 1980”s, a period that ironically also coincided with watershed changes in political leadership: the victories of Thatcher in 1979, Reagan in 1980, and Mitterrand in 1981.  Elections drive policy changes,which then affect the economics profoundly.

The Swiss National Bank has taken the lead on what may develop into more pro-active currency management.  SNB officials escalated intervention this past week to counter franc strength, broadening their purchases to dollars as well as euros and operating in North America as well as Europe.  The authorities have only indicated a desire to stop appreciation but may in fact have a hidden agenda to promote some depreciation.  Intervention with the intent of partly reversing a currency trend tends to be more successful than intervention with the objective of defending a level.  The Swiss approach may prove contagious.  There exists greater motivation to meddle in the currency markets than a few months ago.  Exports are more likely to respond positively now that global demand is starting to pick up, and the emergence of negative inflation in several economies poses a danger that deflationary medium-term expectations could take hold.  Officials in Canada and New Zealand, who have both complained that recent rises in the loonie and kiwi are unwelcome, are obvious candidates for turning to stronger forex medicine if the verbal variety doesn’t work.  Tokyo officials clearly prefer the high 90’s to the low 90’s.  ECB officials have cultivated a reputation for hands-off management, but the Bank’s President, Trichet, made his infamous remark in November 2004 about recent dollar weakness being “brutal and unwelcome” when the euro was in fact trading ten cents lower than now at around $1.30. Beijing officials give no hint of resuming the appreciation of the yuan against the dollar, which was engineered from the summer of 2005 to the summer of 2008.

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


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