Diverse Movements in Foreign Exchange
July 19, 2013
Great stability around the $1.30 level continues to characterize the key EUR/USD relationship. Coming into 2013, the euro was expected to trade considerably weaker than this threshold. For the past several years, in fact, there have been analysts predicting a return to par, based on Europe’s relatively weak economy, the fragility of Europe’s banks, and the possibility of some countries abandoning the common currency. The euro’s resilience seems to reflect several factors.
- Central bank rhetoric can influence currencies as much as, and at times by even more, that central bank actions. The ECB is a greater practitioner of tough love than the Fed. The conditional hint of quantitative Fed tapering is packaged within framework that accentuates the U.S. economy’s continuing weaker-than-acceptable performance. The ECB promises a supportive accommodative policy but warns that some goals are beyond its range of influence and that nothing will be done that undermines the basic mandate.
- It is the habit of European leaders to act only when necessary to save the euro, investors have a healthier respect for the political commitment to not let the euro break apart.
- Euroland’s balance of payments has improved. A EUR 100.7 billion current account surplus was recorded over the first five months of 2013, equivalent to $26.5 billion per month. The common currency area’s “basic balance,” which combines the current account and long-term capital flows, widened thirteen and a half-fold from EUR 19.8 billion in the first five months of 2012 to EUR 267.8 billion in January-May of 2013.
The dollar has experienced considerable strength this year against the currencies of emerging markets. A graphic in last week’s issue of the Economist depicts losses of 10% or more between May 1 and July 9 in the Brazilian real, Australian dollar, Indian rupee, and South African rand, while the Turkish lira sank over 8%. These economies need capital inflows to finance current account deficits, and investor sentiment in their currencies has been hurt by softer global growth prospects. Worries about European demand have been augmented by concerns over how hard and for how long China will slow.
Emerging market monetary authorities are now responding to the risk of a vicious cycle of reinforcing currency depreciation and capital outflow activity. Brazil’s Selic rate was recently raised 50 basis points and has climbed 175 bps since April. Bank Indonesia also tightened its reference rate by 50 bps. India’s marginal standby facility was lifted 200 bps to 10.25% explicitly to counter FX volatility. In Africa, central bank rate hikes occurred recently in Zambia, Ghana, Egypt, and Tunisia. The latest minutes from the Reserve Bank of Australia reflect greater reluctance to cut rates further partly because of the Aussie dollar’s recent slide.
An election in Japan this weekend is likely to consolidate the hold on power of Prime Minister Abe’s Liberal Democratic Party and thereby strengthen his ability to fight deflation and promote growth. Yen depreciation was a key element of that strategy thus far. If given a choice to have the yen stay where it is, start to strengthen or extend is decline in an orderly fashion, the government would no doubt select the last option of more depreciation. Paradoxically, one would think that continuing ample growth and the emergence of positive inflation would lend the yen strength. But in the present context that includes rapid growth in the monetary base, an LDP victory on Sunday that secures an upper house majority likely will be a negative factor for the currency.
Taking a cue from the Fed’s strategy, the Bank of England is considering a data-driven policy framework that puts greater stress on forward policy guidance. In this way, markets can become more confident that policy isn’t going to tighten soon but also may conclude that fresh quantitative easing is likewise not in the immediate picture. Indeed, U.K. data have been lately better than expected. Without a change by the Bank of England so far in 2013, sterling fell from as high as $1.6280 to as low as $1.4812, but it recently has steadied just a penny and half under its year-to-date mean of $1.54.
Two wild cards to watch as summer evolves are the influences of uncertainty over the occupancy of the Fed chairmanship and the trend in ten-year Treasuries. The dollar’s biggest threat on the first of these factors lies not in the identity of Mr. Bernanke’s successor but rather in uncertainty that the transition can occur seamlessly and in a timely fashion. The 10-year yield had risen since early May lows by over a full percentage point to 2.76% earlier this month. Only a quarter percentage point of that advance has been reversed, and the 2.50% present yield remains 54 basis points above the average level in the first half of 2013 and 71 bps greater than the 2012 mean. That’s higher than officials believe to be consistent with an anchored fed funds rate through mid-2015, and it represents an undesirable rise in real interest rates given sub-target inflation. Two questions to be answered in coming weeks are how Fed officials respond and how much higher long-term rates affect the U.S. economic recovery.
Copyright 2013, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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