Currency Market Chatter Can Be Misleading

April 9, 2010

A Greek chorus is an ever-present fixture of currency market trading.  A market participant can formulate opinions and trading strategies from the relentless drip of new information — data releases, comments made and general news — or from market conditions (how market prices and volumes are behaving) or from unsolicited remarks about the market by other people like yours truly on Currency Thoughts.  In this age of Twitter, Facebook, Linked-in and smart phones, the Greek chorus is louder and more intrusive than one could ever have dreamed when the dollar began floating in 1973.  A web search of “foreign exchange” produces a vast menu of commentaries and sites with trading advice and training courses.  In ancient Greek theater, the chorus was all knowing about the past, the present and, yes, what lay ahead and shared what it knew in opinionated ways.  So it is with the foreign exchange chorus, which is similarly judgmental and self-promoting — but also fallible.

News flash: the clairvoyance of the chorus isn’t as foolproof as it’s cracked up to be.  However much one tries not to use the rearview mirror, it’s unavoidable because that’s where hard, as opposed to soft, information gets learned.  The road ahead is mere conjecture.  Meanwhile, currency animals like to run with the herd, so views get amplified and simplified into black and white, rather than shades of gray, by the chorus.  Situations that are good are painted as very good, and bad stuff comes across quickly as very bad until conventional wisdom suddenly seems ill-conceived and people jump from the old bandwagon to a new one.  The Greek chorus loves to sink its teeth into political issues, especially those that fester.

The chorus’s focus on the Greek debt difficulties is fitting indeed.  The lack of a single fiscal policy was a huge design flaw in the European Monetary Union, with potentially negative implications for the euro under the wrong circumstances, and we are in just such a time.  This is not a figment of the chorus’s imagination but a reality of the marketplace that sees the euro in its fourth straight month of difficulty.  From a 2009 high of $1.5144 on November 25, it fell as much as 12.4% against the U.S. currency and has lost ground against several other key currencies as well.  Listen to the chorus, however, and the impression one gets is of an intensifying downward spiral with no good endings for the common currency.  Any good news like today’s reports of forthcoming details and unanimity in the earlier EU agreement gets drowned out by bad news like the concurrent announced two-notch downgrade of Greek debt by the Fitch credit rating agency. 

Examine the price behavior of EUR/USD, however, and one finds diminishing momentum in its rate of depreciation.  The euro set lower lows than the week before  in 14 of the last 19 weeks and lower highs in 13 of those weeks.  But the euro’s low this past week was just 1.3% weaker than its low six weeks before (the week of February 26), compared to a 6.1% drop between the lows in the week of January 15 and the week of February 26 and a decline of 3.3% between the lows in the weeks of December 4 and January 15.  This week’s euro high was likewise 1.2% softer than its high six weeks earlier.  In such comparisons over the previous two six-week increments, the weekly highs had dropped by 6.1% and 3.7%.  Flawed procedures for handling fiscal problems were a very serious omission but not necessarily a fatal mistake.  Not every constitution is written perfectly.  Surely, the founding fathers of the U.S. republic committed an equally significant error in preserving slavery, and that didn’t lead to America’s permanent dismemberment.  It remains to be seen whether European leaders show enough cohesion and joint desire to hang together.  However, that element of this saga plays out, a nucleus of EMU members will persevere whose determination to preserve the internal and external values of European money should never be doubted.  The euro’s mean value over the first five years of existence, $0.9927, is clearly unacceptably low.  The mean of $1.4122 in 2007-9 was stronger than desired but not enough so to be countered by officials.  The Goldilocks setting of $1.2480 on average over the three years of 2004-06 was likely most ideal and represents a minimal objective if Greece is misplayed and leads to larger dominos falling. 

Sharp distinctions in the future monetary policies in Euroland and the United States cannot be confidently drawn at this juncture.  Each will depend on unfolding price and growth trends, not a prescribed advance timetable.  Economic factors are unlikely to be a source of a major cumulative movement in EUR/USD.  One complication over the coming month will be sterling, which will march to the beat of pre-election opinion polls.  The risks seem to be skewed downward because Britain’s fiscal problems are enormous and daunting for whatever government emerges.  However, I suspect the uncertainty of the vote on May 6 will mitigate actual price action in the pound during April and keep the market’s primary focus on euro this month.

The yen’s historical tendency to perform well in April, a counter-intuitive pattern given the start of a new fiscal year, wasn’t looking like reliable guidance in the first couple of days of this month when it depreciated briefly past 94.5/$, but the end of the first full week of the month finds Japan’s currency with a minuscule uptick from the end-March level.  Japan’s economy looks better.  Officials have the assessment correct of moderate growth that’s not yet on a self-sustaining footing.  The BOJ at end-April may up the ante of unconventional measures to reduce deflation, but that needn’t be a negative development for the yen.  Deflation, unlike low inflation, is something that needs to be and should be eradicated.  Japanese interest rates can’t go lower, and U.S. and European ones aren’t going to be rising for a while.

Where there’s smoke, investors anticipate fire.  The period of advent for a rising yuan seems to be building up to a decision.  If China wants to justify a policy shift on data trends rather than enlightenment after hearing the arguments of other governments, the next 1-2 weeks would seem to be the time for action.  China announces its usual slate of monthly indicators next week, as well as first-quarter GDP growth on Thursday.  An interest rate increase certainly seems near, either alone or in conjunction with a currency gesture.  From the script of 2005-8, when China’s exchange rate climbed in a highly managed fashion by 21% or less than 7% per annum on balance, any rise will be extremely slow at first, and renewed movement is unlikely to impact other currencies very much.

In the past week that saw the dollar have very scant net changes against the Swissie and euro but fall otherwise, the currency-sensitive currencies were clear winners.  The loonie has met resistance at parity with the greenback, frequently starting the North American day on the strong side but then sliding back to the weaker side of par.  It’s hard not to be upbeat about the Canadian, Australian, South African and even New Zealand currencies if one is reasonably confident about global growth and raw material prices.  At the same time, realize that much of the grounds for optimism is coming from information observed in the rear-view mirror.  Commodity prices and this group of currencies have already done well.  The big trial for them will be to see how global and G-7 demand holds up while policy support is gradually removed and whether that process is adequately coordinated among countries and between monetary, fiscal and financial market policies.

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

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One Response to “Currency Market Chatter Can Be Misleading”

  1. Jimbo says:

    Great article! Good news for my Canadian, Australian, and New Zealand currencies!