Curtain Rising on 2012

December 30, 2011

Currency movements in the opening weeks of the year tend to be volatile and favor the dollar.  During the 26 Januarys from 1976 through 1998, the dollar advanced against the mark eighteen times between December 31 and January 15.  The average absolute move in dollar-mark was 2.1%, with a 1.1% net mean change including the five years when the dollar in fact fell in the first half of the first calendar month.  This bias counterbalances a seasonal tendency for the dollar to decline in late December, but the whip-sawing pattern has become less pronounced since the common currency was born at end-1998.  Over those thirteen observations, the dollar fell six times against the euro, rose in five other years during the first half of January, and was twice unchanged.  Despite this rather even distribution of gains and losses, the dollar on net rose 0.7% on average, and its absolute change during this period was a swing of 1.5%.  Moreover, the 1.5% figure seems to understate the extent of volatility at the start of the calendar year.  In 2011, for instance, the dollar advanced against the euro by 3.5% in the first week of January only to drop 3.6% in the second week of the month, producing a change over the first half of January amounting to negative 0.1%.

The dollar seems well positioned to extend its impressive December gains as they were grounded in a number of tangible developments.

  • ECB monetary policy has been eased aggressively under Draghi despite the hawkish rhetoric of the central bank’s new president and other top policymakers at the institution.  In addition to reversing earlier interest rate increases implemented in April and July, a special three-year refinancing tender provided banks with a massive infusion of liquidity at 1.0%.  Without calling the action quantitative easing, ECB officials have moved very close to a form of virtual QE stimulus.
  • In all likelihood, January should see more credit rating downgrades involving the members of the common currency area.  Market attention is especially focused on the possibility that S&P will remove France’s triple A country risk assessment.
  • The temporary extension of the U.S. payroll tax cut boosts the chances for better-than-forecast data in the early going of the new year.  Europe fell into recession during 4Q11 and will remain so at least into the spring, but hope persists that the United States economy will manage to withstand the fallout and thus widen its advantageous relative performance vis-a-vis Europe.
  • Japan’s recovery has also stalled.
  • Yen appreciation continues to be largely contained by the threat of Japanese intervention.
  • Softer gold prices since September indicate lessening anti-dollar sentiment.
  • Dollar market technicals appear supportive.  In spite of the aforementioned historic tendency to sputter in the autumn and especially late December, the dollar has strengthened through 1.30 per euro and is closing 2011 at its best levels of the year against the common European currency. 

2011 was a paradoxical year in that extreme uncertainty and volatile currency swings at times didn’t add up to much of an end-2010 to end-2011 change.  At 15:00 GMT on this last trading session of the year, the U.S. currency had risen by merely 0.5% over the past twelve months against the Swiss franc, pound sterling, Australia dollar and New Zealand dollar.  It’s unprecedented in the floating exchange rate era to have that many sub-1% net changes among key currency relationships.  Other major dollar relationships also exhibit muted change:  the greenback is up 3.2% against the euro and 2.2% versus the Canadian dollar but down 5.8% against the yen.  The government-managed yuan rose 4.7%, a bit more than its 3.6% rise against the dollar in 2010 but a much smaller gain than favored by U.S. politicians.  The besieged euro, struggling for its very survival all year, suffered surprisingly small net declines in 2011 of 2.6% against sterling and 2.5% versus the Swissie.  A bigger net drop of 8.7% against the yen, which hit a three-year high of 99.97 per euro in this final session, stayed in single-digit territory, nonetheless.

For much of 2011, the dollar seemed inversely correlated with U.S. equity market trends.  There is a certain elegant satisfaction to the fact that major share price aggregated indices are also ending 2011 near their starting levels.  Unfortunately, a wide spectrum of stock market 2012 forecasts leaves one with little guidance regarding the prognosis for the dollar over the coming year.  One of the biggest mistaken forecasts a year ago came from a camp of analysts that thought 2011 would see the euro fall back to parity at some point.  Such analysis was right to assume no credible remedy to fix the euro debt crisis but insufficiently factored in the erosive long-term effect from reserve asset diversification.  The United States remains a weak saver, so its chronic current account deficit will persist as a negative factor for the dollar.

If Europe’s problems degenerate into a full financial market rupture such as seen after the collapse of Lehman Brothers in September 2008, the predictors of euro-dollar parity may indeed prove wrong only in the timing of their projections.  But if 2012 more closely resembles the political muddle of 2011 than the ultimate extremes of late 2008 and early 2009, the diversification machine will continue to grind away, and the dollar is unlikely to achieve the potential gains that fundamental economic comparisons might seem to warrant.  Given the polarization of possibilities, it’s best to play the coming year week by week, if not day by day. 

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

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