Pause in the Dollar

March 12, 2010

Upward pressure on the dollar has lost steam.  As of 16:00 GMT today, the U.S. currency was showing losses for the week of 1.3% against the Canadian dollar and Swiss franc, 0.9% against the euro and Australian dollar, 0.6% relative to the kiwi but only 0.2% versus sterling.  Previous dollar strength had been mostly at the expense of European currencies and not shared with the yen against which the greenback has posted period averages of 89.86 in the fourth quarter of 2009, 91.24 in January, 90.23 in February, and 89.82 so far this month.

Currency markets never tire of dwelling upon future monetary policy prospects but have a difficult time sustaining an attention span on special factors like the Greek fiscal woes.  That issue persists but is no longer a market decider.  Greek public-sector unions are in the fight of their lives to preserve perks and resist benefit give-backs.  It remains murky what the rest of the EU is prepared to offer Greece in aid and how much support might be required, if any.  Possible contagion to other fiscally vulnerable members of the euro area is another unknown quantity.  For now, the conventional assumption is that no EMU members will defect and that somehow Greece will manage to raise the heavy funds needed this spring to service its debt.

Some of the dollar’s strength late in 2009 and earlier this year reflected a vote of low confidence in Europe, but two other elements originated from optimism about the United States.  One was that the dollar had become very oversold, having weakened 48.7% against the euro between October 2000 and July 2008.  Despite a subsequent recovery of slightly more than 19% to 1.3435/EUR, the dollar remained 12% below its all-time average level against Europe’s common currency.  Mere speculation about a possible break-up of European Monetary Union, even if absurd as ECB officials assert repeatedly, seemed sufficient to discredit the chance of the dollar squandering its reserve currency status.  2010 has seen fewer headlines than last year about big dollar holders considering diversification away from the dollar.

The other broad issue behind more bullish sentiment toward the dollar coming into this year was a perception in the markets and among analysts that the U.S. economy will outperform Europe and Japan in 2010 and 2011, paving the way for less synchronized monetary policymaking than currently exists.  Such opinions are reflected in the latest Economist monthly survey of sixteen prestigious chop shops of economic analysis.  Their average 2010 growth projections show advances of 3.1% in the United States, 1.7% in Japan and 1.2% in the euro area.  For next year, the pundits predict growth of 2.9% in the United States, roughly twice as much as the projected GDP increases of 1.6% for Japan and 1.4% in Euroland.  Such a pecking orders seems intuitively reasonable, since it mirrors the ranking of economic growth rates between 4Q08 and 4Q09 of minus 2.1% in the euro area, minus 1.0% in Japan and plus 0.1% in the United States.  Another pro-dollar sign is the steeper U.S. yield curve.  Ten-year Treasury yields are more than 50 basis points higher than comparable 10-year bund yields even though three-month rates are lower in the States than in Europe.

In other respects, however, the United States fails to earn the top admiration of investors.  For one example, industrial production has lately advanced solidly in the United States but even more rapidly in the euro area and Japan.  The table below presents 1) fourth quarter against third quarter annualized increases 2) January monthly non-annualized advances against December and the fourth quarter levels, and 3) the latest on-year comparisons.

  4Q vs 3Q Jan/Dec Jan/4Q Jan/Jan
U.S. 4.7% 0.9% 2.1% 0.9%
Ezone 7.9% 1.7% 2.5% 1.4%
Japan 19.3% 2.7% 4.8% 18.5%


Trilateral comparisons of inflation, current accounts and fiscal imbalances do not favor the United States, either.  Over the last twelve reported months, consumer prices increased 2.6% in the United States and 0.9% in Euroland, while falling by 1.3% in Japan.  Whereas the U.S. current account will likely record another deficit in 2010 that exceeds 3.0% of GDP, Japan is running a like-sized surplus, and Euroland’s external imbalance is inconsequential, recording a deficit of 0.1% of GDP in 3Q09 and a surplus equal to 0.2% of GDP last quarter.  America ran up a record monthly fiscal deficit in February of $221 billion and is on the way to full-year imbalance of more than 10% of GDP.  The budget deficits of Japan and Euroland, although unsatisfactorily high at 7-something percent, are significantly smaller than the U.S. shortfall.  Long-term and short-term interest rate differentials between the U.S. and Europe haven’t changed much since the beginning of this year.

The FOMC and Bank of Japan Policy Board hold meetings next week under contrasting circumstances.  The FOMC used the expression “economic recovery” for the first time this cycle after its January 27th meeting and implemented the first of a likely sequence of discount rate increases in an inter-meeting action three weeks later.  There have not been verbal hints of a change in the key phrase “…likely to warrant exceptionally low levels of the federal funds rate for an extended period.”   However, further upgrades to the economic assessment should be dollar positive.  While the Fed edges closer to policy normalization and an eventual increase of the federal funds rate, the Bank of Japan seems poised to go the other way. New quantitative easing measures are widely expected next week, either an extension of the 10 trillion yen injection of 3-month, 0.1% funds done in early December or, better yet, an increase of the central bank’s monthly sum of outright JGB purchases.  The yen is softer now than in early December but not as much so as Japanese officials would like.  Besides, money and credit growth in Japan remain anemic.  Anticipated end-of-fiscal year yen demand from capital repatriations are once again proving to be a dud.  The yen tends to perform better in April than March, contrary to what theory would suggest.

The juxtaposition of central bank meetings in Japan and the United States sets up a good test for the dollar.  On paper, the U.S. currency should get a lift, but often more information is learned from how forex markets react to economic news than from the news itself.  If the greenback fails to rise as these two central banks announce their conclusions, the downward dollar pressure of this past week could intensify.  Dollar/yen hasn’t been stronger than 93.1 since the first week of January.  Against the euro, in comparison, the dollar had risen from a fourth-quarter 2009 mean value of $1.4790 to means of $1.4093 in January and $1.3676 in February.  Right now, the euro is exactly midway between $1.35 and $1.40 and a bit more than 1% below its March-to-date average level.  Considering potentially supportive developments like the job gains of 200K or more that several analysts are penciling in for March, one senses a crossroads for the dollar.  It’s expected to keep strengthening but may need first to regroup closer to 1.40 against the euro.

After touching lows of $1.478 in the first week of March and $1.487 this past week, sterling took advantage of the dollar’s pause and advanced past $1.51 but lagged behind the rate of appreciation in other key currencies.  The pound will remain vulnerable, so long as investors doubt that a credible strategy of medium-term deficit reduction can be put in place.  Elections must be held by June, and polls show no party scoring a sufficiently decisive victory to enact legislation that would appease antsy speculators.  A less hawkish Swiss quarterly Monetary Policy Statement than expected, suggests a willingness to wait longer before raising interest rates, especially if the franc climbs further against the euro.

For dollar bulls and critics of Europe, who nonetheless suspect that EUR/USD may be now in a consolidation phase, the Canadian currency offers a suitable alternative to ride the better global recovery.  Canada’s labor market is outperforming its U.S. counterpart, and Canadian trade is back in surplus.  Since December, Bank of Canada officials have talked of a possible rate hike early in the third quarter, whereas the FOMC has given no comparable timing signal.   Indeed, if unemployment stays closer to 10% than 9% as seems probable, the funds rate may go nowhere in 2010.  Another commodity-sensitive currency, the Australian dollar, is likely to attract interest later this month, as traders wonder about a possible fifth Australian rate increase in April.

Finally, remember that as the United States moves back to daylight savings time this weekend, the time difference with Europe will be shortening by one hour.  Good luck with the Ides of March on Monday and Saint Paddy’s Day on Wednesday.  The snows have melted almost fully, and spring is in the air.  But some things never change.  The chatter from China indicates continuing resistance to a modification of currency policy.  That economy looks too hot again, meaning that monetary conditions will have to get snugged one way or another.  A Chinese interest rate hike seems  likely before officials agree to any upward adjustment of the yuan against the dollar.  Obama has delayed his visit to Asia for the final push on health care legislation.  As the FIOS ad says, “this is big.”  Whatever the outcome of the healthcare reform bill, the subsequent reaction of the financial community including to the dollar will hold great interest to investors and politicians alike and could be a watershed in the marketplace.

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

Tags: , , , ,


Comments are closed.