Will May’s Strong Currency Moves Extend Into June?

June 1, 2012

The euro remains a currency in crisis.  It took a terrible beating in May, plunging 8.3% against the yen and 6.6% relative to the dollar.  Euroland’s economy is caught in a self-inflicted trap.  Zombie banks are losing deposits.  Many members are in recession, some severely so, and no politically feasible policy remedies in the short run exist to prevent the outlook from deteriorating further.  Most officials believe their economies will be even more damned if Greece leaves the union, so resistance against Grexit from other countries will remain strong for now.  Such a scenario my yet prove unpreventable depending on the result of this month’s Greek election. 

The U.S. and Japanese economies are also fragile, but not as much so as Europe.  That favors easier monetary policy in Europe to a greater relative degree in the future than now, and this in turn imparts more downside risk to the euro.  It was looking as if the Federal Reserve would remain on the sidelines rather than undertake a new controversial round of quantitative easing in the middle of a presidential election campaign, but today’s awful jobs reports raises new doubt about that possibility.  Average growth in jobs of 96K per month over the three months to May was 62% less than the prior monthly pace of 252K in the three months to February.  The Bank of Japan may expand its quantitative policy support further, but officials there do not face a situation that is as desperate as what is happening in Europe.  The point is that the economic and political fundamentals that depressed the euro last month will be sticking around during the summer.  In order for the euro’s fate to change, either investors need to conclude that the currency has dropped enough, or officials will need to take direct or indirect action to halt the trend.

The euro does not appear to have fallen so excessively as to become self-correcting.  It’s closing level in May of $1.2335 represented a dollar recovery of 30% from the all-time low of $1.6038 in July 2008.  One can find historic examples of major currency moves surpassing 30%. Here are some.

  • From $0.8228 per euro in October 2000 to the $1.6038 peak in 2008 constituted a euro advance of 95%.
  • From $1.1876 in January 1999 to the October 2000 euro low was a 44% appreciation in the dollar.
  • The dollar rose 105% from DEM 1.70 at the start of 1980 to DEM 3.48 in February 1985.
  • The yen strengthened 133% from 280 per dollar in the early 1980’s to 120 at end-1987 and later by 100% from 160 in early 1990 to 80 in April 1995.

The euro moreover remains stronger than a number of key benchmarks.  In June 2010, it weakened as far as $1.1878.  That’s objective looks readily attainable before autumn.  Also nearby are the euro’s opening level of $1.1720 from December 31, 1998 and its lifetime mean of $1.2083.  Given the dire circumstances of the Euroland economy, it will not be good enough for the currency to merely settle down near these centers of gravity.  Eventual equilibrium should lie considerably lower than such benchmarks to lend support to exports for an economy desperately in need of sources of growth.

The more likely way that the euro’s present downtrend might halt prematurely lies in direct action from governments and central banks to support it.  Initiatives from the ECB or European governments seem unlikely because depreciation isn’t fanning inflation.  Oil and commodity prices are in fact falling, so inflation will move lower over coming months. Appreciation in the dollar, yen, and Swiss franc, however, threatens to augment unwanted weak growth and disinflation and will displease officials in those countries.  A Fed stimulus announcement in summer has not been generally expected and is therefore not priced into foreign exchange rates.  Japanese officials continue to express frustration about the yen’s strength and could enter the markets to buy dollars and euros in response on a unilateral basis.  The Swiss National Bank could become a source of incremental euro demand if purchases of euros by that institution are increased to keep the CHF/EUR ceiling target from being compromised.  Swiss authorities have revealed that capital controls might be imposed.  When used in the mid 1970s, regulations did not prevent the franc from climbing even more sharply than the mark.

The euro’s southbound path is also vulnerable to unexpected headline news.  Important European elections and summits lie ahead this month.  U.S. opinion polls at the moment depict a close contest for the White House and control of Congress, so the outlook for U.S. fiscal policy is very uncertain at the moment.  For some time I’ve believed the tide will turn eventually in Romney’s favor and now anticipate such a development happening sooner rather than later.  When asked, money movers in the financial community tend to favor the anti-regulation and small-government stance of the Republican Party, so one would think that a rising dollar/falling euro predisposition could be reinforced by strengthening expectations that Romney is going to win.  The problem there, is that the dollar and other vital U.S. economic signs have performed better historically under Democratic presidencies.  For a direct comparison of U.S. trends in the Bush43 years and since Obama began his term, also see this article. 

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



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