No End to Uncertainty

October 10, 2013

In this age of ubiquitous economic and political uncertainty, the budget deal that Democrats and Republicans are said to be fashioning merely postpones the day of reckoning for several weeks.  Despite today’s palpable market relief, nothing has been settled in an enduring way. The very existence of such uncertainty dampens economic growth, so the latest budget developments are not a cause for great joy.

The dollar has been comparatively stable against the yen and euro since the spring but, despite more supportive interest rate differentials, is weaker than in 2012 when it averaged 1.2869 per euro and JPY 79.82.  Against the euro, the dollar posted quarterly mean values of 1.3200 in the winter quarter of 2013, 1.3058 in the second quarter, and 1.3354 last quarter, and it’s been trading this week mostly on the weak side of $1.35.  The bulk, but not all, of the rise in dollar/yen occurred before the start of the current monetary policy to double Japan’s monetary base in two years was launched a half year ago.  After a mean of 92.30 in 1Q, the dollar averaged 98.64 yen in 2Q and 99.24 last quarter.  That relationship is now trading at 98.11. 

In circumstances different from now, the U.S. government shutdown in November 1995 was associated with dollar appreciation.  That closure from November 14 through November 20 is already briefer than this one.  Dollar/mark at 1.4191 when the shutdown began rose to 1.4370 by yearend and had appreciated 8.3% by May, 14, 1996, a net gain of 8.3% over six months.  Dollar/yen concurrently went from 101.92 to 103.40 by yearend and 105.38 by May 14 for a gain of 3.4%.  This happened during an era of accelerating U.S. economic growth of 4.9% annualized in the first half of 1996 compared to a 3.2% pace in 2H95.  The ten-year Treasury yields rose about 75 basis points to 6.71%, and CPI inflation edged up to 2.9% by May 1996 from 2.6% six months earlier.  Presidential leadership grew bolder as the 1996 bid for a second term approached, and the Dow Jones Industrials exhibited plenty of exuberance, too, rising 15.5% between November 14 and May 14.  America’s federal budget was transitioning into surplus, and the brief shutdown of the government did not fan subsequent expectations that more shutdowns lay ahead.  Those times were marked by more contrasts than similarities to the present and therefore offer scant clues to what now awaits the dollar and other financial markets.

One uncertainty has been removed, the identity of the next Fed Chairperson, but opinions differ on what the choice means.  I believe Janet Yellen has been type-cast unfairly as a proverbial dove, like Nancy Teeters and Martha Seger, former Chicago Fed Presidents between 1978 and 1991, who by their voting records were FOMC doves for all seasons.  Ms. Yellen, by contrast, is a proven top tier economist whose opinions have been driven by the application of reason to empirical evidence.  Importantly, she’s performed outstandingly as a forecaster of economic trends, which will prove a great asset to Fed policymaking given the central bank’s mediocre record in the past when predicting the future.  Considerable uncertainty awaits the transition to new Fed leadership on other scores.  Markets need to learn a Yellen’s communications style and skill. She will be joined by several newcomers on the Board, and she succeeds Bernanke at a time of unprecedented congressional hostility toward the Fed.  It remains to be seen what negative effect, if any, follows from the poorly disguised fact that she wasn’t Obama’s first choice.  These kind of intangibles can’t be understated.  The market image of central bank leaders weighed heavily on the first ECB President and contributed mightily to the euro’s steep slide in 1999-00.  More recently, BOJ Governor quickly secured considerable market trust that got his program off to a decent start.

Currency markets must grapple with other continuing uncertainties.  Investors wonder about what coalition takes power in Germany and the impact of Germany’s recent election on efforts to integrate the members of the monetary union in areas such as banking.  The global economy in the Great Recession was saved in part by the resilience of emerging economies led by the BRIC group.  Now just as nascent recovery surfaces in Europe and Japan, growth prospects have worsened among emerging economies, and the global economy has fewer growth impulses than one would like to see as the Great Rebalancing continues.  When the Doha Round of multilateral trade talks, which started a dozen years ago, floundered, many experts predicted dire consequences would ensue.  Indeed, there was a horrendous global recession, Europe’s debt crisis, upheaval in the Middle East, and considerable soul-searching that Western-style democracy may have hit an irreparable impasse that renders such not only unsuitable for transplant in emerging nations but impotent in the West where such had served people well in the past. For Japan, the ultimate verdict on Abenomics hasn’t been cast, but concern has been raised but the continuing lackluster performance of wages, the government’s timid approach to structural reform, and the ever-mountain fiscal debt, which now hovers not far from 250% of GDP.

In an age of uncertainty, forecasting market trends has become a murky exercise.  When other fundamental economic yardsticks yield conflicting noise, one might do a lot worse than looking to the price of gold for guidance.  The metal’s weakness over the recent past has coincided since summer with a mixed dollar: stalled against the yen, somewhat softer against the euro, but buoyant versus emerging market currencies.  If you’re a dollar bull, you want to see a decisively downward trend in gold even from current levels.

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

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