Dollar Absorbing Twin Body Blows
September 19, 2013
It’s been a difficult Thursday-to-Thursday statement week for the dollar, which got sandbagged by yesterday’s Fed surprise not to begin reducing quantitative easing. In the period, the U.S. currency suffered losses of 2.8% against the kiwi, 2.2% relative to the Swiss franc, 1.8% versus the Australian dollar, 1.7% against the euro and 1.5% at sterling’s expense. Gold, which is oftentimes an inverse barometer of dollar sentiment, advanced 2.9%.
A new potentially negative dollar factor has now popped up on investors’ radar screens: a looming debt ceiling crisis and the possibility of a debt default. House Conservatives will play very tough, because President Obama is seen by them as a skilled political campaigner but a weak leader who can be counted on to cave in when pressured. By the same token, Obama is a wounded and thus dangerous adversary. His presidency has passed through a very difficult period and appears on the edge of shreds if he’s outflanked on the debt ceiling talks. Because the White House and House of Representatives are each incentivized to put personal issues above the national interest in this tug-of-war, a debt default seems much more likely to result this time than in July 2011.
Currency behavior around that earlier episode is consequently not a great guide to what happens to the dollar this time around. In 2011, the dollar was not discernibly affected, not even after Standard and Poor’s downgraded the U.S. credit rating on August 5. The euro weakened from $1.4910 in early May 2011 to $1.2672 early in January 2012, while the yen, which had been very strong when the debt ceiling crisis first emerged, remained so for the balance of 2011 and most of 2012 for that matter. If the U.S. government defaults this time, the dollar is unlikely to be insulated, and a game of chicken that proves to be a miss will also strike a more significant blow this time because dollar sentiment already is grappling with the Fed taper than wasn’t just yet.
In fact, the Fed story is still evolving. Officials will continue probing for a way to begin normalizing policy but in a way so gradual that markets become convinced that a 4% fed funds rate, the ultimate desired peak, isn’t reached until 2017, 2018 or perhaps even later. The FOMC statement on September 18 didn’t send the market back to square one, that is the psychology early this year, and it’s doubtful that long-term rates will retrace substantially from here. I wouldn’t expect the 10-year Treasury yield to drop under 2.25% again this year, for example. All the while, the Fed leadership is entering a period of substantial transition. For now, investors think a dovish mentality will continue to dominate the hawks. That needn’t slam the dollar. What matters more than what the FOMC does is whether investors perceive the policy to be appropriate, that is offering more benefit than harm. It will take months for a consensus on this question to solidify, but the fiscal showdown will not wait for that. Fiscal strains will probably hurt the dollar more than in 2011, because the monetary backdrop is more unsettled now than then.
As pointed out in earlier FX Insight essays here, current accounts tend to get overshadowed in market chatter by matters of macroeconomic policy. But while the currency implications of shifts in demand management are often ambiguous and dependent on context, current account deficits are a negative factor pretty consistently. As a percent of GDP, the U.S. current account gap was marginally smaller last quarter than either in 1Q13 or full-2012. But the capital flow funding of the deficit was less reliable and lower in quality. Official capital swung from a significant net inflow to a modest outflow, and net private capital support masked a lengthening outflow in long-term portfolio investment and direct investment. These points are illustrated in the two following tables.
Billions of dollars | 2Q13 | 1Q13 | 2012 |
Current Account | -98.9 | -104.9 | -440.4 |
% of GDP | -2.4 | -2.5 | -2.7 |
Private Capital | +104.5 | -20.7 | -34.4 |
Official Capital | -5.6 | +125.5 | +474.8 |
The above table is pretty self explanatory. Note that because the balance of payments adheres to double-entry bookkeeping, the sum of the current account, private capital and official capital flows is zero or nearly so because of rounding error. The next table needs some explanation. I’ve broken down private-sector portfolio investment and direct investment into its eight components: U.S. direct investment abroad, foreign direct investment in the United States, private foreign purchases of U.S. Treasuries, corporate bonds, agency bonds and equities, and U.S. purchases of foreign bonds and stocks. Negative signs in the first two columns signify net sales. The third column labeled “change” is positive if the second quarter enhances a net inflow, reduces a net outflow, or represents a switch from net sales in 1Q to net purchases in 2Q. The sum of the third column entries indicates an $18.6 billion increase in net portfolio and direct investment combined outflows from $149.5 billion in 1Q to $168.1 billion in 2Q, and this shift suggests a more fragile foundation of dollar support.
Billions of USD | 2Q13 | 1Q13 | Change |
U.S. Dir Invest Abroad | 95.5 | 84.1 | -11.4 |
Fgn Dir Invest in U.S. | 37.9 | 28.6 | 9.3 |
U.S. Buying Fgn Bonds | 3.8 | 60.0 | 56.2 |
U.S. Buying Fgn Equities | 76.3 | 73.8 | -2.5 |
Fgn Buy U.S. Treasuries | -0.3 | 50.8 | -51.1 |
Fgn Buy U.S. Corp Bonds | 19.8 | 32.3 | -12.5 |
Fgn + U.S. Agency Bonds | -20.1 | -19.8 | -0.3 |
Fgn + U.S. Stocks | -29.7 | -23.4 | -6.3 |
Copyright 2013, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
Tags: Dollar, U.S. current account