Lots of Puzzles to Ponder

June 6, 2013

The dollar at today’s lows of 95.90 yen and 1.3306 per euro had depreciated 7.6% against the yen since May 22 and 3.8% against the euro since May 17.  This slide was associated with the softest patch of equity market performance so far this year. 

Investor expectations haven’t been very consistent.  One perception is that the rise in  long-term interest rates will continue.  Rising Japanese JGBs has been a consequence of an aggressive monetary stimulus to end deflation, goose inflation expectations, and actually achieve positive 2% inflation by spring 2015.  The FOMC is thought likely to start tapering off quantitative easing within a few months, and ECB officials are hopeful that further stimulus can be avoided.  Prospects have diminished for additional stimulus by the Bank of England, as the U.K. economy shows signs that it will continue to recover.  Brazil’s Selic interest rate was raised last week by monetary authorities. 

A lot of concern has surfaced in the financial community that the United States will not handle policy normalization well.  The market question of the day is where to run.  Bonds look clearly vulnerable, but equities have also corrected downward this week.  With more disinflation to be found than inflation, commodities are sucking wind.  Against gold, the dollar is 23% stronger than its 52-week mean and 15.3% better than a year ago.  Two ironies spring to mind.  A hallmark of the last six years has been a tendency for stock  markets and the dollar to trade inversely, but this week they have fallen in tandem.  Secondly, why be so sure the Fed will taper it liquidity injections soon if doubts persist about the economy’s ability to tolerate such medicine.  Doves at the Fed have repeatedly stressed a desire to proceed only once the coast is clear.  They needn’t act with dispatch now, since inflation remains far from its circuit-breaking threshold, and labor market properties continue to offer a mix of encouraging signs with some very disturbing conditions as well. 

Investors are wondering if the prime minister of Japan has no clothes.  The label Abenomics developed even faster than Reaganomics or Obamacare, and the first impression of the new leader was that he was truly a miracle worker as the yen, long-term interest rates, share prices and GDP each moved decisively in the intended direction.  Abe acted quickly on two of the three pillars of his economic policy, and became the first leader since Koizumi to have rising poll ratings.  When long-term bond yields rose in April and May, the need to ad lib arose, however, but Japanese officials instead projected confusion over how to proceed.  Confidence has been shaken, and the yen is back on the bid side of 100/dollar. 

A rising yen oftentimes takes demand away from the euro.  Not so this time.  EUR/USD is still in a tight orbit around $1.3000 but back on the strong side of that center.  The news is not all bad on the euro front however.  The euro has relinquished some gains against the Swiss franc and is steady against the pound.  The franc actually could use more franc depreciation, since Switzerland is still experiencing deflation.  The improvement of British data, meanwhile, has been more notable than the news out of Continental Europe, where trends are more depressing.

Commodity-sensitive currencies should be weak, and they have to an extent.  Soft commodity prices are a part of the disinflation story.  Central bank officials in Australia, Canada, and New Zealand continue to comment about the persistent strength of their local currencies despite a downtrun in the the terms of trade (ratio of export to import prices).  The U.S. currency is 7.5%, 2.4% and 2.1% stronger than a year ago against the Aussie dollar, kiwi, and loonie.  A much bigger gain of 18.2% has come at the South African rand’s expense. 

China’s a wild card.  Beijing officials have managed to retain the primacy of price stability as a top priority even as economic growth in China has undershot expectations and led to downward revisions of likely future growth.  A rising yuan would help contain inflation, but officials are being ultra cautious in permitting appreciation.  In the nearly eight years since an 11-year yuan peg at 8.277 per dollar was ended, China’s currency has risen at a controlled average annualized pace of 3.9% against the U.S. currency.  The annualized rise so far this year of 3.7% has been marginally smaller than that pace.  One doesn’t hear these days much complaining from Western governments much complaining about Chinese foreign exchange policy.  Nor does talk of Chinese diversification into the euro get mentioned much.  The governments in the U.S., Europe, and Japan are too preoccupied with their own domestic problems and political scandals.

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

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