How Bullish Should One Be About the Dollar?

February 26, 2010

This past week saw the dollar perform better in the minds of analysts than in the marketplace.  Gloom about Europe’s peripheral members — affectionately known as the PIIGS for Portugal, Italy, Ireland, Greece and Spain — generated further speculation that the euro might be headed for divorce or worse, a failed marriage.  Even so the dollar was barely changed on a Friday-to-Friday basis (at 15:30 GMT) against the euro, Swiss franc, kiwi and Australian dollar.  Gains of more than 1.0% were recorded against sterling and the Canadian currency, but the dollar also slumped nearly 3% against a rejuvenated yen.

Today just happens to be the 25th anniversary of the dollar’s strongest values during the entire floating exchange rate era, that is post-March 1973.  So it’s a good time to take stock of the dollar’s long-term trend and more recent movement.  The table below documents the U.S. currency’s net changes against selected other currencies over the last 25 years, five years, six months and three months.

USD versus 25 Years 5 Years 6 Months 3 Months
Mark -58.7%      
F. franc -54.6%      
Euro   -3.2% +4.6% +10.4%
Swissy -66.0% -8.2% +0.6% +7.1%
Yen -66.0% -15.6% -5.6% +2.8%
C-dollar -24.7% -14.8% -3.1% +0.1%
AUD -21.9% -12.6% -7.6% +2.0%
Kiwi -37.0%   -2.4% +2.6%
Sterling -31.9% +25.3% +6.2% +8.4%


The dollar’s fundamental trend has been downward over the past 25 years.  Note that America’s high inflation had already ended by the start of this period.  CPI inflation had retreated to 3.5% by February 1985 and averaged 2.9% per annum over the ensuing 25 years.  Earlier double-digit inflation had indeed depressed the dollar but is not the reason for the U.S. currency’s secular downtrend since 1985.  Dollar losses over that period were pervasive and large, exceeding 50% against the yen, Swissy, and components of the euro like the mark and French franc.

Shorter-term comparisons yield a more ambivalent picture of the greenback.  Dollar movements over the last five years were also mostly down, a 25.3% appreciation against sterling being the notable exception.  The five-year loss against the euro was small, but declines against the yen and commodity-sensitive currencies exceeded 10%.  An examination of the dollar’s performance over the past half-year reveals a mixed result, with gains relative to the euro and pound, a minuscule change relative to the Swiss franc, and losses against commodity-sensitive currencies.  Only in the shortest time duration against levels around Thanksgiving 2009 do all the comparisons favor the dollar.

Overall it is not so much growing dollar strength but rather relentless sterling weakness and a recent erosion of confidence in the euro that one finds.  The yen and commodity-sensitive currencies are mostly holding their own.  The case of sterling is interesting because the pound was the world’s preeminent reserve currency before the dollar.  Like the United States, Britain muddled through several years of very unsatisfactory inflation, but currency weakness has persisted beyond that era.  The legacy of any currency that’s been a reserve asset or continues to be so is the existence of large pools of offshore holdings of that currency, and that makes them a convenient target of negative speculation.  The dollar has trended downward even though its stranglehold on reserve asset portfolios remains undented.  If that role so much as softens and the dollar starts to share that favored status with another currency, its susceptibility to downward pressure would intensify greatly.

The euro clearly has a serious immediate problem, however.  Nobody doubts that the dollar will be around in five years or fifty years.  The same assurance is missing about the euro, and that confidence gap is impeding the common European currency’s development as a reserve asset alternative.  Moreover, Euroland’s emergence from recession stalled last autumn, and regional growth and inflation are still tracking below expectations.  Investors consequently expect the Fed to move ahead of the ECB in tightening monetary policy.  A flaw in that logic is that a near-term rate hike by either central bank remains quite far away.  It’s not enough for U.S. GDP to grow robustly for a quarter of two.  In fact, the Fed is mandated to promote the growth of employment, not GDP.  Next Friday’s U.S. labor force survey will reveal a glass more empty than full, and the ECB press conference is likely to take a hard line on Greek debt.  A probable fourth rate increase by the Reserve Bank of Australia, in contrast, will direct attention to the strengths of economies that are commodity exporters and/or which do considerable trade with China and other Asian emerging markets.

March is the final month of Japan’s fiscal year, and this time each year produces a lot of chatter about the yen benefiting from repatriated capital to window-dress end-of-year balance sheets. In point of fact, dollar/yen has not exhibited a particularly strong directional bias during March in past years.  Over the last nine of them beginning in 2001, the yen rose five times and recorded an average rise of 0.3% between the end of February and end-march.  The split during the previous 21 years saw the yen climb against the dollar 11 times in March and post a mean gain of 0.5%.  For all 30 years, the biggest yen advances were those of 6.8% in 2001, 7.0% in 2000, and 11.7% in 1995, while the largest declines in March occurred in 1990 and 1991 (each time by 5.6%) and 2004 (4.8%).  Japanese officials are uncomfortable with the yen stronger than 90 per dollar and can be expected to intervene verbally in hope of coaxing the currency back to 90-something before end-March when balance sheets will be priced.  A week after the euro peaked against the dollar in mid-2008 at $1.6038, it crested against the yen at 170.0.  Over the ensuing 19 months, however, the yen has risen 40.6% against the common European currency to stand currently at 120.9.

The week ahead will be a busy one for data junkies.  Many of the scheduled releases aside from the U.S. labor report are manufacturing and service purchasing managers indices from a lot of countries, Canadian GDP, Euroland retail sales and producer prices, German industrial orders, and Japanese labor statistics.  The central banks of Australia, Britain, Euroland and Canada all hold monetary policy meetings.  Only Australia’s will change rates.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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