Topsy Turvy Currency Trading from One Day to the Next

April 13, 2012

This holiday-shortened past week exemplified the undecided sentiment of the currency marketplace.  It’s healthy for conflicting opinions to compete in currency trading.  Shifts in the balance of power between different views and the bulkiness of commercial transactions and large capital movements that hit the market create noise that can obscure a sense of market direction.  All this is natural and part of the art of projecting future currency rates.  Lately, however, collective behavior itself has been swinging to and fro from one day to the next.  Convictions about the medium term are not held strongly, nor are market players focused on unearthing the big picture.  The stress instead is on agility, riding a train for a stop or two only and then hopping to one going the opposite way.  Economic data haven’t been any more mixed than one typically encounters, so plenty of excuses to shift direction arise from the normal stream of economic indicators, remarks by officials, and other eye-catching developments.  Success lies in jumping at the right time, that is slightly before others do.  These dynamics that prioritize the journey over the destination present a challenge to medium-term currency forecasting.

Below are some of the highlights of recent currency price actions.

  • Having been jawboned lower to 84.18 per dollar in mid-March, the yen is again hovering near 80.  The year-to-date average of 79.64 is not far from the current level and likewise close to the 2011 mean of 79.73.  Japanese authorities prefer the yen to trade between 85 and 95 per dollar.
  • The euro continues to resist selling pressure when it nears $1.3000, whose support was last breached in mid-February.  One mustn’t lose sight that the year-to-date mean of $1.3112 represents a weakening trend from averages of $1.3808 in the second half of 2011 and $1.4039 in 1H11.  That being said, the euro remains a dime above its life-time average of $1.2075.
  • Those in search of longer rides can find them in the EUR/JPY relationship, in which the euro strengthened almost 15% from 97.05 on January 16 to JPY 111.44 on March 21 but then fell 5.4% to 105.46 on April 11.
  • The avowed defense by Swiss officials of a franc ceiling of 1.2000 per euro appears increasingly unenforceable.  The franc has been stronger than 1.22 since January 6 without interruption and on the strong side of 1.2100 exclusively since March 16.  More ominously, market chatter has begun comparing the Swiss policy to the failed attempt to keep sterling in the EU’s former exchange rate mechanism.  That experiment was abandoned on September 16, 1992.  When fixed currency pegs are discarded, sudden large movements with considerable speculative profit often follow.
  • Cable (dollars per British pound) continues to be a boring currency to watch.  Sterling has traded above $1.56 since the beginning of March and above $1.58 since March 26. 
  • For little apparent fundamental economic advantage, the kiwi has advanced almost 5% against the Australian dollar this year.  Traders believe the kiwi’s out-performance has been fed by favorable capital movements that could persist in the period ahead.
  • The up and down nature of the dollar was on display this past week.  Net movements from the end of last Friday  through a while ago were limited to dollar gains of 0.3% and 0.1% against the Swiss franc and euro, zero change versus the yen and sterling, and declines of 0.5%, 0.7%, and 0.8% relative to the Australian, Canadian and New Zealand dollars.  These movements were less remarkable than the associated 19-basis point drop of the ten-year Treasury yields, the slide in U.S. share prices, and a 2.4% advance in the price of gold.

What then can break this currency logjam?  The answers lie in plausible assumptions with far-reaching policy implications, and the U.S. election offers one source of fertile ground.  If he can stay healthy and avoid scandal, I believe Mitt Romney will unseat President Obama for four reasons.  America’s high jobless rate presents a huge problem.  It will be above 7.2%, the usual dividing line between incumbents getting re-elected or ousted.  Second, Obama has uncomfortably high disapproval ratings.  Third, super-PAC money will put the Republicans on an equal footing with the Democrats in terms of financial resources, in contrast to the lopsided edge that Obama enjoyed four years ago.  And fourth, nobody has perfected the art of negative advertising better than Team Romney, and negative ads have decided U.S. elections since 1964. 

Another reasonable assumption is that Spain and possibly Italy will most likely need to get explicit bailout aid packages before the end of 2012.  Those economies lack sufficient growth to escape the trap that is now closing on them.  New ideas are needed, but probably will not emerge.  A third presumption concerns Fed policy, namely that the pro-growth bias championed by Chairman Bernanke is not discarded.  Rate guidance for the remainder of this year will continue to put the likely timing of an initial hike in 2014, not 2013 or 2012.  My view on this question stems from expectations that U.S. growth will lose momentum next year.

The rising possibility and eventual shift to a Romney Presidency has negative implications for the dollar.  Many tax increases that otherwise are set for 2013 will not happen, but the fiscal drag on the U.S. economy will be greater than if Obama wins because of a shift in the composition of austerity toward lessening spending from the government.  It is also an historically empirical fact that U.S. stocks and the dollar tend to perform more weakly when the president is a Republican.   Fed independence will be under great suspicion when the Republicans take power, since the replacement of Chairman Bernanke has been a priority of that party’s faithful.  For yet another thing, new administrations of either major political party have been tempted to neglect the dollar in hopes that a little depreciation might lift competitiveness.  More broadly, foreign policy is apt to revert to the confrontational pre-2009 approach, a stance that bred ill-will among friends and foes.  For a country dependent on capital inflows, collateral damage of such a policy could befall the dollar.  Finally, a paradox of U.S. history is the generally poor performance of the economy under presidents with a background in private business, and that too suggests new dollar tension. 

Trading in the second half of this year and beyond will be subjected to opposing forces, the implications of U.S. government change on the one hand and the fall-out of another acute euro debt crisis on the other.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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