Currencies Not the Main Market Attraction

November 15, 2012

Economic conditions still look bleak in the United States, Euroland, Britain and Japan a little more than five years after the start of the global financial crisis.  Between the third quarters of 2007 and 2012, real GDP climbed only 0.5% per annum on average in the States, while sliding at a 0.3% annual rate in Britain and Japan and at a 0.2% annual pace in the euro area.  Experts warned in 2007 that the road back to historical norms would require patience, and for those who’ve taken comfort from that wisdom, it’s been a frustrating wait for Godot.  On-year growth over the four quarters to 3Q12 amounted to zero in the U.K., +0.1% in Japan, and negative 0.6% in the euro zone.  America, where GDP has risen 2.3% since 3Q11, has been the one-eyed economy in the land of the blind, but a recession in 2013 is inevitable if the fiscal cliff’s drag, estimated to be slightly over 4% of GDP, is not modified.

Stock markets have greeted Obama’s election victory in much the same fashion as experienced four years ago.  The Dow Jones Industrials dropped some 5% within seven business days after November 6, not quite as much as the 8.2% slide clocked in the equivalent span after Election Day 2008.  Accrued losses in the Dow mounted to 32% by March 9, 2009.  In 2008-9, the dollar and yen thrived on dangerous economic news.  That pattern is reflected in the U.S. currency’s changes since November 15, 2007:  a decline of 26.7% against the yen but appreciation of 28.9% versus sterling and 14.6% against the euro.  This tendency has become less pronounced lately.  The yen has weakened 1% against the dollar since the U.S. election, reacting hardly at all to U.S. or European developments.  Geopolitical tensions with China, Japan’s slide into a third recession since 2007, and anticipated changes in Japanese macroeconomic policies have been the main drivers. 

Coming changes in Japanese leadership are depressing the yen.  The Bank of Japan governor serves a single term of five years, and the current term of Governor Shirakawa ends next March 19.  His successor and other top appointees will be chosen by Japan’s government but not the people leading now.  An election in mid-December is likely to return the Liberal Democratic Party to power, and Shinzo Abe would become prime minister and is promising substantial additional stimulus from both the monetary and fiscal side.  The central bank’s defense that current monetary support is “powerful” is undermined by the persistence of deflation.  Consumer prices in Japan fell 0.3% annualized both over the past five years and during the most recent twelve-month period.

Currency movements since the U.S. election have in fact been understated relative to shifts that have occurred in bonds and equities.  The yen, for example, is still trading 39% above its 25-year average of 114 per dollar and doesn’t reflect the full fall from economic grace experienced by Japan.  Japanese fiscal debt has mushroomed to twice the size of the economy.  A once mighty trade surplus has been transformed into a deficit, and a rare seasonally adjusted current account deficit was posted in September.  The Japanese Nikkei, which has caved 77% since the end of 1989, provides a much better sense than the yen of the deterioration in Japan’s present value. 

The EUR/USD relationship has hardly moved on balance since the U.S. election.  The euro has just a couple of supports — immense political commitment not to let the common currency break apart and a central bank that is not transparently seeking currency depreciation.  ECB official rhetoric is more hawkish than the Fed on the goal of price stability, but the U.S. and Ezone economies had the same inflation during the past five years.  Against those positive factors are a number of potential negatives.  If a way cannot be found to make the peripheral members more competitive, euro reversibility will gain appeal.  Second, while ECB officials do not say disparaging things about the euro, they are not averse to policies that tend to weaken a currency.  Both the Fed and ECB are widely expected to initiate fresh stimulus next month.  Third, German’s distrust the euro, and Bundesbank leaders have not been discrete in complaining in public about the majority’s poliicy decisions.  Fourth, upcoming fourth-quarter data are expected to confirm a sharp intensification of the region’s recession.  Fifth, the euro is the natural foil against which the dollar ought to benefit if geopolitical conditions in the Middle East go from very bad to even worse.  Sixth, the United States has better demographic trends than Euroland.  Seventh, the euro area is becoming more dependent on imported energy, while America is getting less so. 

Two central banks not chomping at the bit to ease are the Bank of England and the Bank of Canada.  Inflation-containment has been less successful in Britain than in the United States or euro area.  Consumer prices in the latter two economies each rose 2.1% per annum in the past five reported years.  Britain’s pace was 3.3%, and the latest on-year change was also higher in Britain (2.7%) than in Euroland (2.5%) or the U.S. (2.2%).  Minutes from the November Bank of England meeting indicated some ambivalence about expanding quantitative easing next month.  Canadian monetary officials likewise have retained an upward bias on policy interest rate bias, even though the target rate hasn’t been hiked since September 2010.

Today marks the seven-eighths milepost of 2012.  The state of GDP growth and labor market conditions among developed economies is poor, and inflation for the most part is sufficiently subdued.  Politicians by and large are not following the Keynesian policy recommendation to bridge the private sector’s slack.  One rule of thumb in currency forecasting is to bet on currencies where macroeconomic policies are well-customized for treating the top and most pressing  problems and to short currencies where the mix of monetary and fiscal policies seem inappropriate.  Some of this year’s inertia in foreign exchange movement may have been caused by the fact that nobody’s policy priorities seem quite correct.

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

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