Major Dollar Relationships in Mark Time March Mode

February 27, 2014

It hasn’t been an exciting January and February for dollar watchers.  The key EUR/USD pair has traded in a 2.3% high-low band between $1.378 and $1.347 so far this year and shows no net change in the latest Thursday-to-Thursday period.  In this statement week, the dollar has edged down 0.2% against the yen, Swiss franc, and sterling while showing slightly less modest rises of 0.5% against the loonie and Aussie dollar.  Watching the frequent criss crossing patterns of Australian and Swiss currencies, which have respectively averaged $0.888 and 0.896 francs per dollar in 2014, has been a little like watching the pairs figure skating at Sochi.

For those seeking a greater thrill, there has been the plunging Ukraine hryvnia, down over 10%, or the Chinese yuan, where about five competing explanations have surfaced to explain its most significant downward correction since 2005.  But these aren’t true market-determined prices.

In contrast to the inertia of major dollar relationships, the 2014 environment is littered with a number of interesting factors.  Here are some.

Fixed-income asset markets have become accustomed to Fed tapering and are no longer afraid.  Back on September 5, 2013, the 10-year Treasury yield was 140 basis points higher than the year earlier, but that 12-month increment has narrowed to 75 basis points and seems likely to keep narrowing.  Fed officials agree that incremental quantitative easing has outlasted its usefulness and simply needed time to establish a strategy of ending the program in a way that markets and the economy can handle. 

How about the U.S. weather, which has come to dominate the nightly news?  Half the country is experiencing the severest winter in years, while the West Coast suffers through record drought.  Abnormal weather creates a smokescreen around economic data that provides ideal cover for the Fed to wind down quantitative easing without indicator-by-indicator second guessing about whether the economy can handle the measured cuts in the central bank’s asset buying.  Weather also obscures the market’s view of what’s happening in the economy.  When in doubt, stand pat, and so the dollar for the most part has.

Over coming months, the European Central Bank will put on a much more interesting show than the Fed.  The March meeting next Thursday of the Governing Council is eagerly awaited to see if and how monetary policy there is eased further.  I believe changes will be made then.  If a case for additional stimulus cannot be cobbled together by policymakers, one has to wonder if any circumstances beyond a clear relapse into recession would be adequate justification.  Since officials have a wide range of monetary policy tools, it will be harder for markets to prepare for the “what” than the “if” of this matter.  Facing fragile growth, sub-target inflation, a risk of deflation, and poor competitiveness in several of euro members, the currency result, at least in the short term, is clear.  ECB policy objectives would be best met if the euro were to decline.  President Draghi needs to find the right words and actions to make the euro lose ground.  It hasn’t happened so far.

Japanese trade has become an object of mounting curiosity.  Given typical sensitivities of export and import demand to a change in the exchange rate, one would expect the trade deficit by now to be shrinking and real export demand to be showing greater vigor.  The failure of that core assumption of Abenomics throws the whole program into doubt.  Prime Minister Abe in response is lifting the ban on nuclear power just three years after the disaster at the Fukushima facility.  This could be a deal with the devil but not very different than the potential environmental risks faced the United States by the dash for energy independence through development of shale oil drilling.  Both programs offer a panacea until and unless disaster strikes, and currency markets will only discount disaster when it happens.  In the U.S. case, meanwhile, fracking presents a way to remove one of, if not the main, drags on the U.S. currency, namely the chronic current account deficit.

Ukraine is not the only instance of geopolitical risk being watched carefully by currency markets.  There been street unrest in Venezuela and Thailand, too.  America’s rival of the future, China, has been up to mischief just like its Cold War adversary, Russia.  The defeated parties of World War II are trying to rise up as well.  Germany and Japan rose up from the ashes economically while assuming far less authority and independent thinking in their foreign policy.  In the euro area debt and growth crisis, German leaders in the government and private sector have not shied away from pushing a Germany-first agenda.  Prime Minister Abe has been much less opaque in charting a nationalistic course for Japan, standing up to both China and the United States.  The more assertive roles of China, Russia, Japan, and Germany will be encouraged by the more isolationist mood of the United States.  How the dust settles ultimately is bound to influence the dollar both in its function as the world’s predominant reserve currency and in its external value against other major currencies.

Four upcoming events that could shape currency trading later this year are

  • European-wide elections to the EU parliament scheduled for May.
  • Whether the new dynamic Italian Prime Minister Renzi is able to walk the talk.  He wants to take the country in a dramatically different direction from the standpoint of deregulation and removing other government impediments to that economy.
  • How well Japan copes with a 60% jump in the national consumption tax from 5% to 8% scheduled for April.  A similar 66.7% hike from 3% to 5% in 1997 contributed to an ensuing recession.
  • The U.S. congressional and gubernatorial elections in November and the politics ahead of then promotes or inhibits effective policymaking by the legislative and executive branches of the federal government.

There’s no shortage of meaningful information flowing, which could stir the dollar’s drink.  It’s just not happening so far.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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