Foreign Exchange Insights

July 2, 2009

The pandemic of investor risk aversion pandemic in the second half of 2008 saw the dollar and yen appreciate strongly.  Big dollar movements in that period were reversed to a sizable but far from complete degree in the first half of 2009 as shown below.  Although the euro at mid-2009 was trading almost exactly at its end-2008 dollar level, the progression of monthly averages in the second quarter — $1.3181 in April, 1.3649 in May and 1.4014 in June — reveals a trend of recent depreciation in the dollar’s most important relationship as well.

The Dollar against 2H08 1H09
Pound sterling +36.5% -11.2%
Aussie dollar +35.4% -12.2%
New Zealand $ +30.4% -9.6%
Canadian dollar +19.1% -4.4%
Japanese yen -14.6% +6.3%
Euro +12.7% -0.3%
Swiss franc +4.8% +1.5%


The 2009 metric underlying the erosion of prior dollar movement has been a perceived reduction in the severity of world recession and lessening anxiety over the threat of a complete breakdown of the international monetary system.  As risk aversion recedes, one also ought to see stocks, commodities, and bond yields rise, yet instead that process has been arrested.  A fifth of the Dow’s recovery from March 9 to June 12th has been given back.  Oil  and gold prices are stalled in the high $60’s and lower $900’s.  One sees from my June in Figures post that both long- and short-term interest rates trended downward during last month.

The $64,000 question surrounding the world economic outlook is whether a truly impressive renaissance of manufacturing in Asia will spread growth to other sectors and regions.  A second fact to be uncovered is how soon economies can be weaned from fiscal deficit spending.  Only then can recovery be called sustainable and the new rates of potential GDP expansion in different regions be estimated with any confidence. Several financial markets are lately revealing second-thoughts about the baseline forecast of a diminishing economic recovery and lessening danger of deflation.  Investors share enough concerns to conclude there is ample reasonable doubt that advanced economies are moving gradually toward recovery.

  • Labor markets are still reeling.  The United States and Euroland each reported a 9.5% jobless rate today, up from 5.6% and 7.4% a year earlier.  Jobs in Japan fell 2.1% in the year to May, a drop that was more than five times greater than the on-year decline as recently as February.
  • Concern is mounting about the health of European banks especially in Germany.  In Euroland, loans to the private sector rose just 1.8% in the year to May, down from a 10.4% increase over the prior 12 months.  The reform of the U.S. banking industry has created bigger, not smaller, institutions and didn’t end the hard-wired incentives that encouraged banks to engage in behaviors that fuels systemic risk.  What ever happened to disarming the economy from institutions that are too big to fail?
  • The Obama administration gets an A for talking about change but has prepared reforms that are not nearly as bold as its talk in such key areas as fiscal support, banking regulation, health care and global warming.  Only in raising projected long-term government deficits has action far surpassed promise.  The best and the brightest economic advisors assembled by Obama hit the road with forecasts that have been shown already to be far too optimistic concerning the severity of this recession.

The implications for key currency pairs under conditions of intensifying or receding risk aversion are very different as the aforementioned table attests.  If the global economy continues to improve, 2H09 changes provide guidance for likely directional risk especially since the magnitude of changes in the second half of 2008 dwarfed the countermoves begun in 1H09.   But if a considerable period of hard times still lies ahead, as the above concerns imply, the first column of the table identifies a different tone that might ensue.  It certainly seems doubtful that the euro and Swiss franc would travel consecutive quarters with almost no net movement against the dollar in either.  The $1.40 per euro pivot is already starting to look a little long in the tooth.

The annual summit of G-8 leaders in Italy late next week is not expected to produce a blueprint for a new international monetary order or even to authorize a committee to draw up such plans and report back to the leaders in 2010. Investors should be on guard, however, for errant comments by officials on the sidelines of the conference that can move currencies and other financial markets sharply without warning.   I wouldn’t bet either on more than lip service for the effort to complete the Doha Round of trade talks.  When multilateral trade negotiations stalled, free traders warned of dire consequences for global growth, touting the role that increasingly free trade had played in the strong growth performance during the second half of the 20th century.  Although failed trade liberalization gets scant attention as a factor in the world recession, the timing soon afterward of the worst economic crisis in 80 years seems more than coincidence.  History suggests that protectionism is not the way to end a deep recession in a timely fashion.

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


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