September Introduces New Stuff to Watch in Currency Trading

September 4, 2014

The ECB announced some meaningful stimulus today.  The Bank of Japan, which made its big play, is now the central bank in need of stimulus that seemingly fallen behind the curve.  The tone of U.S. data has progressed this year from disappointing to mixed to, most recently, increasingly positive.  And the dollar this week has strengthened through the 105 yen and 1.30 per euro barriers.  With the advent of autumn, market players have issues besides the rupture of geopolitical fabric to ponder.

Even though energy has been mostly responsible for the latest downward thrust of inflation in the euro area to a measly 0.3%, that’s an awfully low level for officials at the ECB to have waited before this latest initiative.  It’s not clear how much asset buying will be done, nor what the immediate impact of all the actions taken in June and now will be on growth, economic slack, inflation, and expected inflation.  There is much still to be learned and much to be said for Draghi’s assertion that monetary policy alone doesn’t will not be sufficient and must be complemented by fiscal policy changes and other reforms. The best bang for the ECB’s effort, I believe, will be reaped from a substantial depreciation of the euro, and I think the ECB Governing Council would agree.  So rhetoric in the period ahead is likely to be interpreted as a green light to sell the currency lower.

Euro weakness is problematic for the defense of Swiss National Bank’s imposed 1.2000 franc per euro cap.  Intervention hadn’t been necessary to enforce the goal for some two years, but that could change.

Japanese growth in the third quarter has been tepid at best and does not appear to be as strong as the government or central bank there wanted.  Renewed weakening in the yen is a reflection of dollar strength and not a factor that can be counted upon for higher growth and inflation in the way that the yen’s slide in late 2012 and 2013 was.  But there is another source of hope to be monitored, which is the impressive appreciation of on-year growth in labor cash earnings to 1.0% in June and 2.6% in July.  Previously, lackluster wages had been a great source of concern in assessments of Abenomics, because real wages were being squeezed by inflation especially given the consumption tax hike.

Broader improvement in U.S. economic news provides a perfect foil for the ECB’s action and quest for a softer euro.  With the United States needed European cooperation on a host of foreign policy problems and also seeking a healthier economy across the Atlantic, considerable further euro depreciation can occur without eliciting any complaint.

Technically, the dollar could rise a lot further without becoming seemingly overbought.  This calendar year is more than two-thirds over, yet the high-low spreads of the dollar against the euro ($1.2920 to $1.3993) is just 8.3%.  The 4.7% spread for dollar/yen (105.44 to 100.73) is even narrower.  There have been plenty of years with greater volatility.

Continuing dollar appreciation will not be an immediate problem for the U.S. economy.  Trade data showcase strong U.S. competitiveness, and dollar gains may delay Fed tightening by depressing import prices and overall inflation.  With U.S. wages still subdued, stocks should perform better than their highly elevated levels would suggest.  One of my biggest forecasting miscalculations was being bearish on stocks as early as 1997, a position I defended because I erroneously assumed that equities in the long run would outpace GDP growth by such a large margin because the ratio of profits and wages to GDP tend to be generally stable over time.  That was a bad assumption since the mid-1970s, even if true for decades before.  For bonds, stocks, and short-term interest rates, we’ll know the fat lady’s song is at hand when a discernible uptrend emerges in wage costs takes route, and that’s not yet close at hand.  Until then, ownership will continue offering a better pay-off than work.

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

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