Currency Market Disconnection

January 3, 2013

Industrial economies are fouled up beyond all recognition.  Emerging nations aren’t compensating for this slack in demand.  A whole lot of deleveraging still must be done in the private sector.  Private sector dysfunctionality put strain on public finances, and ill-advised attempts to reduce government deficits now has instead aggravated the private sector mess without achieving intended fiscal consolidation

2012 was a better year than feared even though yearend found Europe and Japan experiencing recession.  Inflation and interest rates stayed down in spite of heavy doses of quantitative monetary easing.  The European Monetary System didn’t break apart, and peripheral sovereign debt yields in the common European currency area settled back significantly in the second half of the year.  Japanese public debt scaled the unbelievable height of 200% of GDP, yet the 10-year Japanese government bond yield average of only 0.85% was below the prior year’s mean for a sixth straight time.  In the United States, a load of austerity slated for this month was watered down immensely by an eleventh hour fiscal deal that simply kicked the crisis some two months outward into the future.

Currency trading remained a daunting way to make a living in part because of a lack of broad trends to ride.  The euro/dollar pair traded in a 12.0% high/low corridor between $1.3486 and $1.2041.  The band’s width was down from ones of 16.2% in 2011, 22.8% in 2010, 21.6% in 2009 and 30.1% in 2008.  On a yearend to yearend basis, the dollar slid all of 1.9% last year following gains of 3.4% in 2011 and 7.0% in 2010, a drop of 2.4% in 2009, and a rise of 4.5% in 2008.  The dollar’s average absolute movement during those five years, 3.9%, was substantially less than that of 12.4% during the first nine years of the European Monetary Union.  Previously, the premier dollar-mark relationship posted average annual moves of 8.5% in the decade through 1998 and 16.0% in the ten years to 1988. 

Dollar-yen exhibited more volatility last year than the EUR/USD relationship.  The yen traded in a 13.9% high-low range between 86.79 and 76.21 per dollar and ended the period 11.3% below its end-2011 level.  The trading band of the yen was slightly greater than in 2011 but significantly less than widths of 28.6% in 2008, 19.6% in 2009, and 18.4% in 2010. 

Besides the uncertain political and economic outlooks, a number of factors seemed to account for the lack of currency market follow-through.  The prevalence of computer-driven forex transactions has made trading less psychologicall, more focused on short time horizons, and susceptible to see-saw patterns.  The economies of the most liquid currencies all struggled, depriving investors of easy investment choices that could play a weak economy against a currency whose economy seemed relatively healthy or likely to become so.  It’s plausible, too, that the saturation of real-time currency market commentaries and news from a variety of media may be additionally stunting the sustainability and impeding the predictability of currency swings. 

Traders took the threat of currency manipulation more seriously.  Politicians always have dabbled at times in currency manipulation, but such efforts are now getting respect and reaping longer-lasting benefits.  Traders used to sneer at artificial attempts to move currencies, believing such to be useless initiatives that in fact create opportunities to make lucrative profits.  But the Swiss defense of the 1.2000 franc per euro ceiling has so far persevered for sixteen months.  Beijing officials continue to disregard foreign protests that the yuan is overvalued and retain complete control over the Chinese currency on a daily basis.  At stronger yen levels than 80 per dollar, Japanese officials repeatedly show alarm about damage to the economy from an overvalued exchange rate.  Although the amount of reported Japanese intervention has been scant and very infrequent, the tight shot group is conspicuous of the calendar year yen highs of 84.83 in 2009, 80.25 in 2010, 75.55 in 2011 and 76.21 last year

Further yen depreciation in 2013 is a top goal of Japan’s new political leadership, and it is prepared if necessary to modify Bank of Japan law regarding quantitative easing and the inflation target.  Prime Minister Abe’s effectiveness will be judged in part by what happens to the yen.  It will be a sign of political failure if the dollar weakens below 85 yen, and only a 90 or 100 handle later this year would be perceived as a break from the interconnected problems of domestic deflation and a rising yen.  Time is not on the prime minister’s side because of an impatient electorate.  He will need to act swiftly especially if the yuan is held generally steady against the dollar.

Japan and Switzerland are not alone in wishing to see weakening currencies.  With inflation contained mostly, depreciation offers a rare means for coaxing more growth from jobs and GDP.  Obama’s reelection gave the Federal Reserve more latitude to stimulate quantitatively, and monetary officials have adopted a framework of tying policy more closely to observable economic results.  But Euroland and Britain will not tolerate a continuing rise of the euro against the dollar and yen, nor should they.  Europe is being subjected to the severest fiscal restraint and has relatively poor economic growth prospects.    Elsewhere, policymakers in commodity-sensitive economies like Australia, New Zealand, and Canada have already acknowledged the drag from strong currencies and will not be content to allow this problem to become more pronounced. 

2013 shapes up to be another year when relative economic fundamentals provide currencies with insufficient and inconsistent directional guidance.  Watch out for currency meddling by governments, all of whom cannot be winners.  For every currency that goes down, another will be rising.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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