Forex Marking Time

January 28, 2011

Four weeks into the year, it remains unclear who will be the big currency market winners and losers of 2011 or how this year might shape up differently from the last one.   In 2010, the dollar appreciated 7.0% against the euro but declined by 12.2%, 11.9% and 9.8% against the Australian dollar, Japanese yen, and Swiss franc.  Despite widespread and frequent calls for a more flexible Chinese foreign exchange policy, the yuan closed only 3.6% stronger than it began last year and has firmed just 0.2% so far in 2011. 

The euro shined brighter in January, helped by a booming German economy, a resilient France, and new confidence that a workable framework will be fashioned finally to hold the monetary union together.  Hints of a more restrictive ECB policy stance as the year unfolds, some reserve asset diversification, and unwinding of long speculative positions in emerging market assets are other positive factors for the euro.  At this past week’s high of $1.3759, the euro enjoyed a 3% year-to-date gain against the dollar.  The euro also strengthened on most crosses.  Its trade-weighted value has recovered a shade more than 3.5% since January 12 to the best level in two months.

The Australian, Japanese, and Swiss currencies are all performing more weakly than last year.  The AUD has pierced parity with the U.S. dollar several times only to falter and slip back below unity again.  Australia’s exchange rate shows a loss of about 3% on balance since end-2010.  Australian CPI inflation was considerably lower than expected last quarter, a reason for Australia’s central bank to take a wait-and-see attitude on further monetary tightening.  Worsening inflation in China meanwhile points to more policy actions by Beijing to cool demand in Australia’s largest export market.

The yen’s 2010 appreciation in 2010 occurred early in the year, and for the past six months or so, it has fluctuated in a 80-85 per dollar band, never crossing its record peak of 79.85 touched on April 19, 1995.  Japan’s enormous fiscal deficit and debt problems drew new attention this past week after Standard and Poor’s downgraded its credit rating one notch to AA-.  Investors have long been more accepting of Japanese than European deficit spending because little of Japan’s debt is foreign-held.  Nonetheless, with government red ink pretty universally hurting currencies wherever such is found, the yen continuing close proximity to its 16-year high seems an anomaly.  Dollar/yen shows scant net change for the first four weeks of 2011.

The Swiss franc is a hard currency par excellence.  At times when paper currencies of all colors fall out of favor and gold is in high vogue, the Swissy tends to break away from the herd and strengthen even against other traditional hard currencies.  The franc has lost around 1% of its value against the dollar this year, and it is no coincidence that this setback coincided with a softer gold price, which is 5.6% weaker than its early-December high.  However, the franc is coming off a well-bid week while playing host to the World Economic Forum.  For those still bullish on gold and other precious metal prices, the fourth week of January should be more indicative of future direction than the performance over the first three weeks of this month.  

It took less than a month into 2011 for geopolitical risk to spike upward.  An unstable Egypt would be an extremely big deal.  Egypt has been a key U.S. ally in the Middle East.  Under Abdul Nasser, Egypt led anti-imperialist and anti-Israeli forces in the Arab world.  Anwar Sadat initially extended that tradition, later tried to broker peace and paid the price of assassination for his efforts.  Egypt has not been at the forefront of Middle Eastern instability during the reign of Hosni Mubarak since 1981, although one of Al Qaeda’s founding fathers was Egyptian.  History demonstrates that the Middle East doesn’t adapt to democracy easily.  Think of Iran, Iraq, Afghanistan and Lebanon.  Egypt faces an unknown future with potentially destabilizing fallout for the entire Middle East, oil prices, and western nations.  The news from Egypt comes after days that saw the Dow Jones Industrial Average struggle to establish a beachhead above 12,000 and creates a somewhat less-than-perfect storm for a downward stock market correction.  Since mid-2007, equity market weakness has often been correlated with dollar strength.  A period marking time for the dollar may be about to end.

Sterling’s prognosis is complicated.  It performed better than I anticipated in 2010, losing 3.5% against the dollar but gaining a roughly similar amount on the euro.  The pound fell last week and is down for the month as a whole despite Bank of England minutes that showed a majority of policymakers inching closer to a future rate hike and less confident about actual and expected inflation during 2011.  Britain’s economy unexpectedly contracted last quarter, and a big question mark to be decided in the next month or two is whether negative growth was a fluke attributable to unseasonably bad weather or the start of a turn for the worse that will be aggravated additionally by severe fiscal restraint.  There are much better European alternatives to the euro than sterling  such as the Swiss franc and Swedish krona, which are underpinned by good public finances and external surpluses.

Among currencies followed regularly for this weekly article, last week’s strongest was the New Zealand dollar, also known affectionately as the kiwi.  In 2010, by contrast, the kiwi had risen only about half as much as the Aussie dollar against their U.S. counterpart.  New Zealand’s central bank has so far hiked its cash rate just twice by 25 basis points from 2.5% to 3.0%.  Australia’s official cash rate has been raised seven times by the same-sized increment, climbing from 3.0% to 4.75%.  That disparity is mirrored in stronger Australian than New Zealand growth, but the gap may be closing. New Zealand Reserve Bank Governor Bollard predicts a healthier pace of activity in 2011, helped by rebuilding damaged areas on the South Island from last year’s earthquake.  New Zealand will be hosting the rugby world cup this year.  Such events tend to lift economic activity at least temporarily and to be associated with currency upticks.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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