The Mother of All Resistance Levels is Par (1:1)

May 11, 2016

Currencies readily alternate between cycles of appreciation and depreciation, but it is a much rarer event for a currency’s unit of account to transition from being weaker than another to being worth more.  Put differently, movements through par, or in the case of USD/JPY 100:1, happen very infrequently. 

Take the key EUR/USD relationship, now almost halfway through its eighteenth year of existence.  When the common European currency was put together at the end of 1998, it was worth more than a dollar and continued so until January 21, 2000.  The euro’s weakest-ever value against the dollar of $0.8228 was recorded on October 26, 2000, and it continued to swim south of dollar parity until early November 2002.  There have not been further cross-overs over EUR/USD par, although one looked imminent fourteen months ago when the euro slipped below $1.05 to a low of $1.0459 on March 16, 2015.  The ECB had begun quantitative easing in mid-2014, and speculation was heating that a rise of the federal funds rate would not be much longer in coming.  It actually took a wait of nine more months for that to happen.  Fed rate normalization has been a slower process than envisaged by U.S. monetary officials at first, but the premise of increasing divergence between Fed policy and the stances of other advanced country central banks has not been question.  And yet, euro support materialized as soon as it fell to within a nickel of parity.  Moreover, equilibrium very near par proved elusive.  The euro has recovered 9% against the dollar from the March 2015 low and roughly 5% since the end of last year.  The common currency is 2.7% above its 2015 mean and shows a 6% trade-weighted appreciation in the span since it hit bottom against the dollar in March 2015.

The biggest currency story of 2016 has been yen strength.  The last trading day of January found the dollar trading as strongly as JPY 121.7.  By May 3, Japan’s currency had recovered 15.3% to 105.55 per dollar.  This was a nightmare in an economy that continues to escape deflation.  Appreciation stifles imported price pressure and depresses expected inflation and confidence in government policy.  Tentative stability has been restored to the yen this month by a verbalized threat that currency market intervention could be used if yen movement remains so one-sided, by which officials meant one-sided in an upward direction.  History shows that it’s been the employment of Japanese intervention that’s one sided, as it has happened virtually always to prevent the yen rising and almost never to resist a decline.  Be that as it may, it’s a doubtful coincidence that Tokyo policymakers made their threats as the 5% gravitational field around 100:1 came into view.  A slide through that psychological barrier could unleash a torrent of speculative demand, so threats of government yen selling carries much greater credibility at 105 per dollar than 110.  The yen’s first penetration of 105/USD in 1993 failed to reach 100.  A second attempt in late 1994 took it all the way to 79.85 on April 19, 1995, but the yen was trading more weakly than 100 again by October of that year.  More than a dozen years would pass before a third penetration of 100 happened in March 2008, and that visit last just a few days.  The longest stretch of time in which a dollar was less valuable than 100 yen lasted from December 2008 to November 2013.  Prime Minister Abe was first elected in December 2013 on a promise to eradicate deflation once and for all, which was viewed as an inconceivable goal unless the yen gave back a lot of its appreciation, which it did.  The slide of Japanese inflation and resurgent yen earlier this year are flip sides of the same problem.  The credibility of Abenomics has eroded badly, and a dollar move back under 100 would constitute an enormous political blow to the government in a year when lower house elections are mandated.

More generally, governments everywhere have become more sensitive to excessive swings in their currencies.  In advanced economies, the problem is fear of appreciation, which can be ill-afforded with inflation so low.  The latest on-year consumer price change is negative in both Japan at -0.1% and Euroland where such is -0.2%.  British, U.S., and Australian consumer prices rose by 0.5%, 0.9%, and 1.3%, which is also too low.  On-year growth in real GDP of 2.0% in the U.S., 1.6% in the eurozone, 2.1% in the U.K. and 0.7% in Japan is likely considered too sluggish.  The Bank of Iceland today decided again not to raise its interest rate, identifying that krona strength as a reason for a flatter rate path than imagined a few months ago.  The presumed Republican presidential nominee, Donald Trump has made trade protectionism a centerpiece of his plan to make America great again in absolute terms but especially in comparison to the circumstances found in other countries.  Among his promises is a vow to declare China a currency manipulator, so the executive branch of government can unilaterally impose trade barriers in reprisal for perceived unfair trade practices that Chinese officials use.

Less than eight weeks remain before the British referendum on EU membership.  The uncertainty of the outcome is already weighing on U.S. output and demand,  Sterling may be vulnerable in the run-up to the vote, unless opinion polls turn overwhelmingly against support for Brexit.  It will not serve political interests if the pound were to be extremely volatile in coming weeks, and the all-clear sign will not be reached immediate after the event.  With growth weakening in the U.K. and inflation far below the target of 2%, the start of rate normalization at the Bank of England remains elusive.

Many emerging markets would like to run macroeconomic policies that promote growth better but cannot because of fear of capital outflows that could drive currencies down and inflation upward.  Perhaps not in the last three decades has the world seemed in a position where it could benefit from grand coordination in policymaking.  This isn’t going to happen.  If anything, the go-it-alone mood has solidified.

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

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