Will Currency Logjam Break Up in May?

April 27, 2012

The dollar fell modestly against the euro and Swiss franc during the last full calendar week of April, a bit over 0.5% against the British and Australian currencies, and slightly more than 1.0% relative to the Canadian dollar and Japanese yen.  Since the start of the year, the dollar has eased by 5.0% or less against the euro, Swiss franc, sterling and commodity-sensitive currencies of Canada, New Zealand and Australia.  The greenback shows a year-to-date advance against the yen of 4.6%and is essentially unchanged relative to the Chinese yuan.  Leaving aside the yen, a semblance of downward drift in the dollar continues to be drowned out by short-term volatility.  Economic fundamentals are not especially useful tools for trading decisions in these choppy market conditions.

At a glance one sees a number of upcoming developments that in normal times might stir the currency market drink next week.  Several meaningful economic indicators will be released — purchasing managers survey results for many nations around the world, labor statistics, money and credit growth, and retail sales from the euro area, and monthly U.S. jobs report.  French and Greek elections on May 6 may augment investor caution.  Central bank policymaking will also be in the spotlight.  There could be continuing reaction to the easing measures announced by the Bank of Japan today and the Federal Reserve press conference this past Wednesday, which sent a message perceived by some to be fraught with confusion and contradiction.  Fed officials are comfortable with their accommodative policy stance, prepared to ease further if support becomes necessary, but warning that it will not have enough tools or will to offset the imposing fiscal cliff at yearend should politicians fail to act before then.  The collective FOMC view after discussion put the likeliest timing of an initial rate hike at late 2014 or beyond, but few members individually expect the end-2014 level to be as low as now.  Like the BOJ, the Reserve Bank of Australia is highly likely to loosen its stance next week and could inspire some Aussie dollar softness.

The monthly ECB meeting is scheduled next week as well amid a deteriorating economic and political scene in the region.  After easing extensively in December and February, the ECB Governing Council’s rhetoric has become more hawkish in a game of chicken with European national governments.  The ECB’s dogmatic view on how to restore growth in Euroland is just as flawed as those of Greece.  The central conundrum of Euroland is that imposing a common monetary policy and removing the option of currency devaluation to participating nations is unsuitable in the absence of political and fiscal union.  It would be helpful but still insufficient if the ECB were to aggressively promote euro weakness against other currencies.  The peripheral nations need to boost competitiveness versus Germany more than against Japan, the United States or China.  In any case, any thought of the ECB debasing the euro would go against every ideological fiber of the Governing Council.  The euro debt and growth crisis has become a chronic condition, and only the timing of a breakup of its present composition seems in great doubt.

Holidays in Japan and China next week will make it had for currency market themes to gain traction and staying power.  Golden Week will shut Japan on Monday for Showa Day, Thursday for Constitution Day and Friday for Greenery Day.  May Day celebrations in China will last from Tuesday through Thursday.  The Bank of Japan, like the ECB, has a suspect commitment to promoting growth through currency softness.  Japanese M2 money expanded at a subdued 2.1% per annum pace over the last decade.  Nominal GDP and the GDP price deflator have contracted over the ten years at annualized rates of 0.7% and 1.4%, respectively.  The yen is 59% stronger than the dollar than it was ten years ago.  The Bank of Japan speaks of “powerful monetary easing,” but with trends like these, clearly not enough to weaken the yen is being provided by monetary authorities, who even after years of deflation associate a lower rate of core CPI inflation (1.0%) with price stability than do any other central banking authorities.

American officials are highly skilled in winning currency wars.  Since Nixon devalued the the U.S. currency in 1971 and again in 1973, most administrations have taken up the torch of currency debasement.  The two exceptions, the first Reagan term and second Clinton administration, occurred under conditions very different from those faced now.  In this age of private and fiscal debt deleveraging, currency depreciation offers one of the few means for economies to survive and for avoiding social chaos.  Even against the Chinese yuan, which is not currently being allowed to climb, the dollar has declined 24% since July 2005.  U.S. officials are not actively jawboning the dollar lower, but make no mistake that preserving a soft dollar is an intermediate goal of the Fed’s campaign to lift inflation and reduce unemployment.  President Obama’s goal of doubling U.S. exports in five years also requires some erosion of the dollar’s value.

If anything, the dollar has not dropped as much as U.S. officials might like.  The dollar is 21% stronger than its July 2008 peak of 1.6038 per euro.  Against the yen, the dollar is little changed from its spot rate a year and half ago of 81.37.  Considering America’s real growth advantage against Europe and Japan, dollar stability for the time being constitutes a moral victory.  When push comes to shove, U.S. officials are more committed to avoiding a strengthening currency and inclined to risk collateral damage from depreciation than their counterparts in other countries.  The full but seldom heard expression of the Rubin mantra from the mid-1990s that a “strong dollar is in the best interest of the United States” added “because it promotes capital inflows, low inflation and low interest rates.”  Those factors already exist now and therefore no longer justify efforts intended to build dollar strength.

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

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