Tougher Dollar Sledding Against the Euro and Yen

February 1, 2016

The strong dollar performance of 2015 carried over into the first month of 2016 against a large number of currencies.  Appreciation last month was most pronounced against commodity sensitive currencies and emerging economy monies and also included the performances against the Swiss franc and sterling.

The dollar’s two most influential relationships moved only slightly on balance last month, however.  The dollar rose 0.8% against the yen and was showing a significant decline for the month until the Bank of Japan’s surprise announcement on the final day, heralding the adoption of a negative Japanese overnight money rate to become effective in the middle of this month.  Moreover, the dollar rose only 0.3% against the euro despite a halving of the 10-year German bund yield during January.

The role of oil partly explains why the dollar isn’t rising faster against the yen or euro.  The U.S. economy is exhibiting less stimulus to personal consumption from cheaper oil than drag to energy sector investment.  Japan especially but also the eurozone and unlike the United States stand unambiguously to benefit from cheaper energy, both in terms of impact on economic growth and also because they already run sizable current account surpluses, which are getting larger as a result.

The dollar’s weaker-than-anticipated performances against the euro and yen are sell-inflicted to a large extent.  America is going through a period of self-doubt to a greater degree than any time since the days of malaise almost 40 years ago.  Trust is way down in the country’s critically important institutions like Congress, the  Supreme Court, the two main political parties, the Federal Reserve, law enforcement, Wall Street, colleges, health providers, big business, and the country’s youth. There is an epidemic of deaths from drug overdoses, and prisons are overcrowded and increasingly unaffordable.  The dark side appeal of the Sanders, Trump and Cruz presidential candidacies have U.S. citizens of the center and a lot of international investors worried about what will be safe come 2017.  The whole basis of U.S. exceptionalism is on trial, namely that the public welfare is best served within an economic system governed by laws, not people, and reliant on market forces to make the essential decisions about what to produce, how best to make things, and the distribution of what gets made. 

The U.S. is not alone in its soul-searching journey.  The migrant issue is more severe in Europe.  Monetary union without political or fiscal union creates considerable political animosity and economic under-performance.  Japan has much worse demographical trends and an economic program that repeatedly has failed to deliver the goal of 2% inflation.  China has run up enormous debt and faces intensifying strain as the government maintains political repression while trying to transition the economy from investment- and export-led growth to a consumption-driven expansion.  What sets America apart is the relatively wider contrast with its own past.  U.S. real GDP grew 3.7% per year over the 50 years through end-1999, but hasn’t expanded as much as 3.0% since 2005 or by 4% since 2000.  The paradigm that lower inflation and stronger economic growth complement one another is now deeply questioned.  The solution does not lie in the promises of “extreme” politicians, who are finding favor with angry voters.  The skill-set of businessmen like Hoover, Carter, and George W. Bush did not transition well into managing presidential power for the greater good. 

To be sure, U.S. growth is still outpacing growth in Europe and Japan, and the above anxieties are rather intangible factors.  In foreign exchange, nonetheless, intangibles matter enormously.  Among central banks, the Fed has become the object of the greatest doubt regarding the appropriateness of its planned interest rate path.  U.S. real GDP expanded at a healthy 3.2% annual rate in the four years of the Carter Presidency, but perceptions about America’s direction and the government’s functionality in that period were poor.  In a period of doubt about President Carter and an interest rate policy that was seemingly always behind the curve in the late 1970s, the dollar took its cue from intangibles like that rather than from GDP growth, and the currency lost a lot of ground. 

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

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