A Stale Currency Market Landscape
August 10, 2015
In these dog days of August, currency movements cannot be trusted to represent the current state of relative economic fundamentals between countries, nor even expectations of future economic and financial market trends. Superimposed upon this seasonal time of limbo, summer 2015 finds investors stuck with a set of uncertainties that has grown stale. Foremost among these considerations is the impact of the coming U.S. interest rate normalization after almost a decade without Fed tightening. This dynamic will be complicated by slower growth in many developing and commodity-exporting economies, Japan’s difficulty escaping from deflation, and the combination of low growth and debt problems in the eurozone.
U.S. monetary tightening has in fact already begun to tighten. The dollar is stronger, long-term U.S. interest rates are higher, and quantitative stimulus ended almost a year ago. The tone of central bank rhetoric, even from Chair Yellen, has shifted in a non-linear fashion but unmistakenly overall in order to prepare markets to anticipated an initial federal funds rate hike soon and to expect rate increases at about a pace of one percentage point per year afterward. The 2013 taper tantrum has not been repeated, which is no small feat given the large decline in commodity prices. Meanwhile, the European Central Bank is committed to a preannounced program of asset purchases at least into early autumn of 2016. With core Japanese inflation at zero, the Bank of Japan cannot get off the merry-go-round of monetary stimulus and probably will need to augment such before a phase-down process can commence. An interest rate hike by the Bank of England will not happen until 2016, and central banks in emerging markets are either cutting interest rates or raising such only because of excessive selling of their currencies and the inflation that such is generating. On paper, the monetary policy picture strongly favors the dollar.
However, the dollar for much of this year hasn’t appreciated as much as the monetary policy setting would suggest. The dollar’s peak against the euro was reached in mid-March, and the peak against the yen happened over two months ago. The greatest vulnerability continues to be reflected in the emerging markets, China notwithstanding. The yuan is not market determined and is therefore a special case that does not constitute a meaningful exception. Part of the failure of the dollar to climb to higher heights stems from non-U.S. factors. Grexit was avoided in the short run, and the bout of negative inflation in the eurozone proved short-lived as ECB officials had predicted. Safe-haven demand amid global uncertainty favored the yen, as a non-European alternative store of value that was neither gold nor the dollar.
The dollar remains well bid, nonetheless. It has strengthened slightly more than 1.0% against the yen and euro over the past two weeks and even more sharply in that fortnight against the Swiss franc. The dollar has firmed a bit during the period against the loonie and kiwi but not the Aussie dollar. Aussie central bank officials, who had repeatedly asserted the need for additional depreciation, recently softened their rhetoric to merely stating that the currency has been adjusting to the significant decline in key commodity prices. The next big events will be the release of eurozone GDP this Friday, the report of Japanese GDP a little later in the month. Then at the turn of September comes U.S. personal income and spending and the all-important PCE price deflator, followed by the August jobs report on September 4. All this will be prelude to the FOMC meeting in mid-September. Beyond that, investors await the onset of a whole new trend or development, currently unknown, to breathe some fresh life into a trading environment that is starting to look old and worn from usage.
Copyright 2015, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
Tags: Dollar, foreign exchange
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