Maybe 2014 Was As Good as It Gets

January 6, 2015

Last year was arguably the dollar’s best-performing year in the last four decades.  On a yearend to yearend basis, 2014 was one of only three years for which the dollar posted double-digit advances against both the yen and Europe’s dominant currency (the Dmark until 1998 and the euro thereafter).  The other two examples were 1997 and 2005.  Of those two precedents, the dollar was best bid in 1997, gaining 16.7% against the mark, 12.5% versus the yen and 12.0% on a trade-weighted basis against a subset of the broad index currencies that circulate widely outside the country of issue.  The dollar had risen against the mark and yen in 1996 as well but to a lesser extent than in 1997.  The Asian debt crisis broke out in the middle of 1997, triggered by a devaluation of the Thai baht.  So 1997 was also a good year for the dollar against many developing economy currencies, but not the Chinese yuan which back then observed a fixed parity with the dollar.  In 2005, the dollar rose 14.8% against the euro and 14.9% relative to the yen.  Its trade-weighted value against widely circulating other monies went up just 8.3%, however, and the gains were recorded from a low basis.  During each of the three years prior to 2005, the dollar had depreciated against both the euro and yen, losing a cumulative 34.4% against the euro and 22.0% relative to the yen.  Last year saw the dollar advance by 13.6% against the yen on top of previous gains of 12.8% in 2012 and 21.4% in 2013.  The dollar also rose 13.7% vis-a-vis the euro, 11.4% trade-weighted against widely circulating monies, and posted quantum leaps against the ruble and many emerging market currencies.  The yuan now moves in a highly managed float, and its direction against the dollar was downward, too.

The years 1997 and 2005 were followed by years in which the dollar did not do nearly as well.  The U.S. currency lost 7.2% against the mark and 13.1% relative to the yen in 1998.  In 2006, it eked out a 1.0% uptick versus the yen but fell by 10.4% against the euro.

Another reason for caution about the dollar in this year that following one of the all-time best relates to the extreme financial market volatility so far this month.  Not a week has passed, and the S&P, German Dax, Japanese Nikkei and British Ftse have each dropped around 3.0%.  Ten-year sovereign debt yields have tumbled by 19 basis points in Britain, 12 basis points in the U.S., 10 basis points in Germany and 3 basis points in Japan.  The 10-year JGB is below 0.30% at a new low of 0.28%, which is saying quite a lot in light of Japan’s long bout with deflation.  The 30-year Treasury yield of 2.53% has tumbled 47 basis points in the last month and 141 basis points in the past year.  This is not propitious backdrop upon which to bet the mortgage and car on the certainty of a Federal funds rate increase sometime during 2015.

To be sure, the dollar opened the new year by extending last year’s rise against the euro.  Bear in mind, however, that a seasonal bias toward appreciation exists against Europe’s dominant currency during the first half of January.  Since 1975, the average advance in the dollar over this period has been 1.1% against the euro and/or mark, and that’s just marginally less than the dollar’s rise this January so far.  Moreover, the dollar, has declined against the yen.

The catalyst for dollar strength in 2014 was mounting confidence that the Fed will be raising interest rates as the ECB launches quantitative easing and the BOJ extends its own quantitative stimulus.  In the weeks around yearend, many lists get published among which are several anticipating the likely biggest imaginable surprises of the coming twelve months.  Some people posited a deferment of a federal funds rate hike past mid-2015 as one possible surprise, but I saw no one sticking their neck out with a call that the central bank interest rate might be still only 0.25% at the end of the year.  If that risk gains perceptible traction in the months ahead, it would be important new information and potentially toxic to long dollar positions. 

The dollar buoyancy last year was supported by other factors that remain in place.  The U.S. current account deficit will be even more manageable in 2014, thanks to the lower cost of imported oil.  Growth in U.S. jobs and GDP showed increasing momentum late in 2014.   Japan and Europe have more serious structural hurdles to overcome.  There’s always a first time, but if the dollar records sizable advances in 2015 against both the yen and euro, it will have done what it failed to do after the only two years that were comparable in dollar strength to 2014.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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