Items of Interest

May 1, 2014

Stability of Dollar/Yen and Euro/Dollar Pairs Continuing

One can only say so much about dollar stability against the yen and euro without getting bored and frustrated.  Currency watching isn’t fun without trend, but stability continues to reign.  Over the first third of 2014, the euro traded between a low of $1.3475 and a high of $1.3967, while the yen fluctuated from a low of 105.44 to a high of 100.73 per dollar.  Neither of those bands exceeds 5% in width, and lately the movement has tightened with the the euro hovering near its top and the yen currently within 1% of center-range.  The reduction in the monthly size of Fed quantitative stimulus, known as tapering, hasn’t buoyed the dollar, partly because long-term U.S. interest rates haven’t risen as much as many investors were expecting.  Meanwhile, officials at the European Central Bank and the Bank of Japan continue to express a willingness to ease policy if necessary but undermined the currency-weakening element of such a message via a visible reluctance to go there.  Until verbal intervention to weaken the yen and euro is backed by concrete policy changes, it will be hard to change a market psychology that has become comfortable with a stable dollar against the euro and yen at levels that are weaker than forecasters were anticipating at the beginning of 2014.


Emerging Market Currencies Steadier Too

As a broadly brushed group emerging market currencies reacted poorly to former Fed Chairman Bernanke’s initial hint almost a year ago that quantitative tapering was likely to happen sooner rather than later.  The somewhat disorderly rise in Treasury yields persuaded the FOMC to begin reducing its asset purchases three months later than intended at first.  A wide array of emerging market monies suffered from abrupt reversals of previous capital inflows last year.  But now that tapering is well along, having been cut almost in half from $85 billion per month to $45 billion, the currencies of emerging markets as a whole are handling this transition much better for three reasons.  First, central banks in many attacked economies responded with currency-defending interest rate hikes.  Second, Fed officials managed over time to convince investors that phasing out quantitative stimulus would not be followed right away by hikes in short-term interest rates and that the slope of the next rate-raising cycle will be shallower than the old normal and wind up at a lower real level than has previously been the case.  Third, U.S. securities have been better behaved during tapering than had been feared.


Sterling at $1.6923 Nears a Five-Year High against the Dollar

Back in my currency forecasting days, sterling proved one of the toughest currencies to forecast especially over time horizons of under a year.  Britain’s economy was clobbered during the Great Recession and continued to under-perform in the ensuing recovery phase under the strain of draconian fiscal austerity.  But lately, the U.K. is not only enjoying better growth than found most everywhere else in Europe but also easily surpassing analyst expectations both from the standpoint of GDP growth and falling-but-not-negative inflation.  Forward-looking data like Britain’s purchasing managers surveys suggest that the good times will keep rolling in the months just ahead.  My experience with sterling instructs me to be cautious.  Like weather in the mountains, the pound’s fortunes often prove changeable.  From a low of $1.4232 on May 20, 2010, sterling has appreciated 19% over the past four years and just 0.7% shy of its five-year high seen on August 5, 2009.


When Might the Dollar’s Reserve Asset Hegemony Be Endangered

The lead story in the April 30 Financial Times deals with a fresh predicted estimate based on purchasing power parity that the size of Chinese GDP will surpass that of the United States this year to become the world’s largest.  The United States has held that distinction without interruption since overtaking Britain in 1872.  This got me thinking, could this be the writing on the wall that the dollar’s stronghold on reserve asset portfolios is at risk.  Wikipedia defines a reserve currency as follows and goes on to note the enormous advantages enjoyed by the country with the most favored reserve currency.

A reserve currency (or anchor currency) is a currency that is held in significant quantities by governments and institutions as part of their foreign exchange reserves, and that is commonly used in international transactions. Persons who live in a country that issues a reserve currency can purchase imports and borrow across borders more cheaply than persons in other nations because they need not exchange their currency to do so.

Go back to the example when the dollar replaced sterling.  This didn’t happen until the inter-war period in the first half of this century, some 45 to 75 years after America became the world’s largest economy.  But there’s an important difference now from then.  Industrialization that began in earnest during the second half of the nineteenth century took many decades to complete.  The world is now transforming at a much more rapid pace.   China’s industrialisation is occurring in a much shorter time span compared with those of the western economies.  This seemingly will inject a new element into how long it will take before the baton is handed from the U.S. dollar to the next predominant currency Hegemon.   It may even be that the role of reserve asset leader will be shared among two or more monies.

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

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