What to Make of Three Helter Skelter Weeks that Felt Like a Year

January 21, 2016

Central bankers tend to be cautious and not prone to scrapping a forecast on the basis of a couple of difficult weeks when developments haven’t jived with baseline assumptions.  But there was the ECB President today declaring that “downside risks have increased again and citing a trio of causes — increased uncertainty surrounding emerging markets, financial and commodity market uncertainty and geopolitical setbacks.  As a result, Mario Draghi strongly hinted that new stimulus is possible in March, and essentially pre-announced that ECB interest rates aren’t rising for an extended time.  Policymakers at the Bank of Japan and Fed will have a chance next week to convey to markets whether they too need to reconsider if their monetary policies are still appropriate.

Today brought a welcome respite to the mailstrom of fear-driven risk aversion.  Oil prices popped up 4%, sovereign debt yields rose too, and so did equities.  Just yesterday, as today’s Financial Times frontpage headline proclaimed, “stock exchanges across the world plunged into bear market territory as oil sunk to another record low.”  One robin doesn’t make a spring, so investors still need to keep seatbelts fastened.

Many stock markets in the early days of 2016 faired worse than America’s, yet without some persistent better news, it’s not hard to imagine 2016 landing on the list of the ten worst years for the Dow Jones average.  The top eight entries on the list are all associated with a recession, panic, or depression.  Four of them occurred in the 1930s: 1930, 1931, 1932, and 1938.  So are the Panics of 2003 and 2007 and  1920 (when the country was in depression) as well as 1974 during the recession induced by the first oil price shock.  The ninth and tenth greatest DJIA declines were in 1917, when the U.S. entered the First World War, and 1966, when domestic support for the Vietnam War soured and when policymakers first fell behind the inflation-containment curve.  The largest calendar year market decline cumulated to 52.7% in 1931, and the tenth largest end-year to end-year slide was an 18.9% drop in 1966.  Earlier this week, 2016 was halfway to replacing year number ten, which occurred a half century ago.  It’s important to realize that if the market drops substantially and persistently enough to be captured in an endyear to endyear change, one can be assured that deterioration on the financial side will be mirrored by meaningful damage to the real economy.  Moreover, if that’s happening to the United States, global economic health will not be doing well, either.

Emerging market currencies have continued to tumble this year.  In 2015, the Brazilian real fell more than 30%, the currencies of South Africa, Russia and Turkey lost over 20%, and Mexico’s peso dropped about 15%.  In the past three weeks alone, the peso and ruble have matched over half of last year’s entire losses against the dollar, the rand has replicated just below a third of its 2015 drop, the real has fallen almost a fourth as much as in 2015, and the lira has mirrored over a sixth of its 2015 slide. 

Among advanced economy currencies, performance in the past three weeks has been very diverse.  Some monies have been stable on a trade-weighted basis, including the dollar (up 0.8%), the Norwegian krone (off 0.4%) and the Swedish krona (down 1.5%).  The yen has been undesirably well-bid, gaining 4.3%, while commodity-sensitive currencies like the Aussie dollar, New Zealand dollar, and Canadian dollar have respectively fallen 6.4%, 6.2%, and 5.2% in trade-weighted terms.  Sterling has lost 3.6%, depressed among other things by Bank of England Carney’s very dovish remarks this week, which squelched any lingering hope that the British Bank Rate, which has been at a record low of 0.5% for almost seven years, might begin normalization during 2016.

In these loflation times, the countries with weak currencies will benefit the most, as such will preserve the price competitiveness of exports and import-competing goods.  During the Great Depression, governments that bailed out of the gold standard early like the U.K. experienced a milder downturn than those like the United States which held out longer.  Part of ECB President Draghi’s dovish comments today no doubt were meant to depress the euro, which to the surprise of many has still not eclipsed the 2015 low of $1.0459 touched last March 16.  The Bank of Japan’s quest to secure 2% core inflation, which includes oil prices, was already looking dubious last quarter after central bank officials elected not to adjust policy in October, but the yen’s upsurge on safe safe haven-seeking capital inflows this year has just made the mission even more impossible. 

A year from now, 2016 may be remembered as the year that currency manipulation evolved from a cold war to a hot one.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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