Paths of Least Resistance

March 7, 2013

The main currency movement since the middle of last year’s fourth quarter has been the yen’s depreciation.  The yen’s sea-change has a solid foundation, being grounded in a lower house parliamentary election that brought to power political leadership with a whole different idea on how best to end Japanese deflation and weak real growth.  A centerpiece of the new agenda is a weaker and more competitive yen that will lift import prices and stimulate demand.

The dollar has climbed 16.7% against the yen since November 15, while sliding 2.6% against the euro.  Among other major currencies, the next weakest unit has been sterling.  The dollar shows a 5.5% rise against the pound since mid-November and has also risen 2.7% versus the Canadian dollar.  These moves are dwarfed by the magnitude of the shift in the yen, however.  Meanwhile, the dollar is virtually unchanged over this span of nearly four months versus the Chinese yuan, Swiss franc, and Australian dollar.  There has been a drop against the kiwi of almost as much as that versus the euro.  These changes give a rough idea of where the paths of least resistance lie at least over the short run. 

To complete the dollar’s ascent to 100 yen, the Bank of Japan will need to walk the walk of its stimulative talk.  Even if the new BOJ Board acts aggressively in April, it remains to be seen if the economy, which appears to be exiting recession, also responds aggressively.  This may in fact not happen.  The smart money among analysts is betting on a soft recovery and inflation staying well below 2% regardless of what transpires on the policy front.  That said, the Abe government has a huge vested interest in achieving quick results because it needs to win the upper house election this summer in order to complete the LDP’s return to power.  So politicians can be counted on to pull out all the stops, and that includes doing whatever it takes to keep the yen’s depreciating trend from stalling.

As for the euro, the $1.3000 level feels like a good equilibrium.  Europe is hardly out of the woods in overcoming its debt and growth crisis.  An ECB interest rate cut still looks reasonably possible before midyear.  There is too much polarization in Ezone growth rates, and it seems that convergence is going to happen at the lower end of the growth spectrum.  But ECB officials are happy to see the euro show resilience because that is the best way to contain speculation that the common currency experiment might break apart.  The key event to watch in Europe is the Italian political scene.  Will the country reject austerity?  It would be hard to do so, given the consequences of such an about-face.

The next looming crisis in the U.S. civil war between Democrats and Republicans occurs on March 27, the deadline for raising the debt ceiling.  Markets have become de-sensitized to this melodrama, as evidenced by the gravity-defying rise of U.S. equities.  The U.S. could also use a cheap currency to support growth, but bureaucrats and politicians have less to lose than their Japanese counterparts if the dollar doesn’t win the race to the bottom.  A steady, rather than a falling, dollar helps shield the Fed from criticism for its quantitative easing.  At the end of the day, yen weakness should remain a dominant market theme because that country’s leaders want it the most.  And in their own discrete way, the new leaders in China will make sure that the yuan doesn’t loose competitiveness at an excessive pace.

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

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