Less Dollar Volatility in First Quarter Than Meets the Eye

March 25, 2019

Long-time readers of Currency Thoughts have no doubt observed a diminished frequency of  “insight” posts on the dollar in this space. A reason for this is that currency markets in recent years have been dominated by unexpected and abnormal political and policy developments to an even greater extent than usual. Surprise shocks are the bane of a forecaster’s existence. Anticipating their timing, not to mention their substance, credibility and and market reaction of such surprises is a pretty hopeless exercise and not one to be undertaken weekly.

Coming into the final week of the first quarter, the time seems ripe to make some sense of what’s happening to the dollar and to check if its really proper to say the dollar is living in volatile times. From the standpoint of cumulative swings, it is not. At last check, the dollar was a mere 1.1%, 0.9% and 0.4% stronger against the euro, Swiss franc and yen than its end-2018 levels. Thegreenback also shows year-to-date declines against commodity-sensitive currencies like the Canadian dollar (1.5%), kiwi (1.4%) and Aussie dollar (0.8%), as well as a larger 3.5% slide relative to sterling. Coming into the final week before the originally planned Brexit D-day, the U.K. economy has shown a bit more resilience than feared, and the outcome of Brexit has become less, rather than more, clear.

In the first quarters of the last four years, the dollar against the euro rose 12.6% in 2015, fell 4.5% in 2016, eased 1.3% in 2017 , and lost 2.6% last year. Relative to the yen, it soared 16.2% in the first quarter of 2015 and then posted first-quarter drops of 6.3% in 2016, 4.7% in 2017, and 9.1% in 2018. So this year’s first quarter has actually been a calm one.

First-quarter high-low spreads in key dollar relationships also have not been especially large this year. In none of the dollar relationships mentioned above was the spread as wide as 9%, and the high/low differential for EUR/USD was only 3.5% so far.

President Trump has characterized the U.S. economic performance as very good and said it would have been super great if not for wrongful Fed tightening. Even in announcing that no rate hikes seem likely this year and only perhaps one move in 2020, Federal Reserve Chairman Powell accentuated positive factors in describing the U.S. economic performance. No officials are talking recession, but they almost never do until after it’s begun.

In comparisons with Euroland, Japan and other economies, the U.S. tends to draw favorable comments, but against U.S. historical norms, the comparisons aren’t glowing — certainly not enough so to put U.S. assets in a greatly appealing light next to investments denominated in other currencies.

  • Quarterly growth in real GDP slowed from 4.2% at an annualized rate last spring to 3.4% in the summer, 2.6% in the fall and probably even less this past winter. The pace in the first quarter of 2019 might even turn out a tad less than the average 2.4% pace over the past five years.
  • Consumer prices rose 1.5% in the United States over the 12 months through February, half a percentage point less than what’s considered optimal and also matching the latest CPI advances in the euro area and China. Japanese inflation of 0.2% has nearly back in a deflationary state.
  • The strongest aspect of the U.S. economy has been the labor market. But the very low 3.8% jobless rate is only that low because of weak labor market participation. If U.S. employment growth after Y2K had matched the 1.83% per annum pace of the 1980s and 1990s, non-farm payroll employment would have risen to 183.8 million workers. That’s 33.5 million more jobs and 22.3% greater than the actual end-2018 levels.
  • To an extent, last year’s historic tax cut bill was a driving factor behind the acceleration of GDP growth, but such proved temporary. In contrast, the ill-timed tax bill from a cyclical standpoint is still feeding the federal budget deficit, which last month set a record high.
  • Heavy government deficit spending under the right circumstances can actually be source of major currency strength. Combined with tight monetary policy and excess productive capacity during the early 1980s, loose fiscal policy then correlated with a rapidly appreciating dollar.
  • More predictable than how the dollar performs with a big and growing U.S. budget deficit is the effect on the trade deficit. The Trump tax bill increased America’s gap between too little domestic saving but much greater domestic investment, and the shift has been met by greater dependence on capital inflows from abroad. The flip side of that is a widening goods and services trade deficit, which grew from $502 billion in 2016 to $552 billion in 2017, $621 billion in 2018, and $717 billion annualized in December. December’s deficit was the largest monthly gap in a decade and represented a 60% increase from the monthly low in 2016-18 that occurred in March 2016.

U.S. economic fundamentals do not produce a strikingly better picture from what is happening elsewhere in the world to overwhelm the inertia-inducing effect from the ever-present event uncertainty that the next news cycle might deliver. Over the past three months, the foreign exchange market has acted with patience, just like the Fed is doing, by not committing strongly in favor or away from the dollar. Investors await clarification of economic trends — such as whether the U.S. yield curve stays inverted and for how long. There’s little confidence that the crazy politics will simmer down before the 2020 election, and there’s the ever-present possibility that President Trump will be confronted with a real big geo-political crisis.

Copyright 2019, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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