Welcome to Summer

May 23, 2013

Wouldn’t it be nice for market participants and analysts if the matters which most influence currency valuation like future monetary policy changes could be laid out in black and white terms without qualifications or two-way causation and feed-back loops?  In such a world, policymaking could be planned a year or more in advance.  One would still have to attach degrees of importance to the array of determinants.  Should economic growth trump the current account, and what’s more important, the change in a variable or its level?  So deciding the likely direction, timing, and degree of future change in a currency would still be complicated, but not nearly so much as in the real world where the policymakers do not know what they will be doing next month or three months from now. 

There have been times historically, for example mid-2004 to mid-2006 for the the Federal Reserve, when policy did seem to operate on automatic pilot.  Over 17 consecutive meetings spaced six to seven weeks apart, the federal funds rate was lifted by 25 basis points in a very steady, predictable, and gradual attempt to transform policy from a very accommodative stance to a neutral one.  That experiment produced a fiasco, contributing to a boom-bust bubble in housing prices and ultimately a serious rupture of the global financial system.  An alternative entirely different path to rate normalization would have been a one-step jump in the central bank rate from 1.0% to 5.25% followed by a declaration that no additional change would occur except if there were to be an unforeseen and extreme emergency.  That, too, would have provided total certainty yet create utter chaos and even sooner than the experiment that Fed officials did conduct.  The point is that what policy-makers might have to do tomorrow depends among many other things on how price and economic trends react today to what was implemented yesterday. 

The Bank of Japan was a pioneer in demonstrating that central bankers cannot always get what they want or intend.  Japan’s overnight uncollateralized money rate has been 0.5% or less since September 1995 not for lack by monetary officials there of wanting to increase them.  Every attempt there to get back to a pre-1991 normal type of policy demonstrated that the economy could no longer handle the old normal.  German authorities pine for the European Central Bank to raise, not cut rates, but that’s not going to happen in a regional economy entrenched in recession and disinflation bordering on possible deflation.  The ECB has had its aborted tries to achieve higher money rates and learned that their economy, like Japan’s, couldn’t handle the old normal.  I suspect the Fed will make the same discovery, and the low tolerance of the U.S. economy for rising interest rates from any level in an environment with an abundance of unutilized factors of production and more disinflation than inflation will be dictating policy, not bureaucratic technicians and not the politicians.

In summer, currency trading can lack the depth, breadth and resiliency of the rest of the year, and the behavioral summer season starts now with the U.S. Memorial Day holiday.  It’s a comparatively short period, ending just fourteen weeks from now at the Labor Day holiday.  Nonetheless, summer often packs a big surprise.  Dollar-gold convertibility ended in August 1971.  Iraq invaded Kuwait in the summer of 1990, and the Soviet Union experienced a failed coup attempt a year after that.  Last year saw ECB Pdt Draghi pull a rabbit out of his hat in the summer, saving the euro from what the markets thought would be imminent destruction. 

Summer is a time to stay alert if possible.  Currency trading can be erratic and sometimes appear divorced from economic fundamentals, but price movement need not cumulate.  Since 1999, dollar-yen has exhibited more lasting movement in the summer season than dollar-euro.  The U.S. currency on averaged fell by 1.8% per year in summer, including drops of 1.9% in 2009, 6.2% in 2010, 5.0% in 2011, and 1.7% last summer.  The dollar by comparison lost a mere 0.1% on average against the euro and changed less than 1% in both 2011 (+0.7%) and 2012 (-0.5%). 

Any seasonal tendency for the yen to strengthen over the coming three months will be in conflict with the preference of Japanese officials.  While mixed signals have been conveyed recently about whether they’d be satisfied with the yen staying at current levels and seeing even more depreciation, one has to suspect that the yen is in a running-to-stand-still dynamic.  If its losses seem capped after so sharp a move during the past six months, market forces are bound to try testing the yen’s corrective potential to rebound.

The euro continues to exhibit inertia masked within a semblance of wanting to break away from the $1.30 level.  It ended 2012 at $1.3193, ended the first quarter at $1.2819, averaged $1.3127 so far this year, and is comparatively close to that level now.  Choppy trading during the summer would be in keeping with the euro’s modus operandi of late.  At the same time, the euro has shared in dollar strength against other currencies, hitting 2012 highs of CHF 1.265 and JPY 133.81 yesterday.  The case of the Swiss franc is particularly interesting.  Swiss officials haven’t changed the 1.2000 per euro level of their cap but at the same time have insisted that economic fundamentals will support eventual further franc depreciation, and that is the currency’s long-term direction that they are expecting.

Sterling has stabilized for now, close to but above $1.5000.  British growth in the first quarter exceeded expectations, but the latest retail sales report was very disappointing.  Inflation in the U.K. exceeds target but by a diminishing amount.  The Monetary Policy Committee of the Bank of England has split 6-3 against increasing quantitative easing at each of the last four monthly policy meetings.  The wild card there this summer will be how markets perceive the new Governor, Mark Carney, who has enjoyed great market respect as the Bank of Canada’s eighth governor and will be installed as BOE governor at the start of July.  In Canada’s disinflationary environment, he hasn’t shied away from calling the Canadian currency overvalued, but Britain is one of the few major developed economies that has experienced too much inflation over recent years. 

Commodity-sensitive currencies will stay vulnerable so long as the dollar trades buoyantly and the global economy remains laden with disinflation.  That ought to cover the whole summer season.  The South African rand already slid pretty extensively as one would expect for a major producer of gold.

Enjoy your summer.

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

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