The Dollar this Summer: Questions and Some Things to Know
June 2, 2021
Movements in the dollar between the U.S. Memorial Day and Labor Day holidays, which define the “summer” trading season, sometimes play differently than at other times of the year. As market participants take vacations, trading desks may lighten, lending an erratic element to the market’s pulse at times, particularly in the face of unexpected events..
The potential for political shocks doesn’t take a break just because it’s summer. The First World War began and the Second World War ended in summer. In August 1971, dollar-gold convertibility and exchange market intervention were suspended by President Nixon. At one of the most chaotic modern times for the dollar, Federal Reserve intervention in favor of the dollar was resumed to “maintain orderly market conditions” in early July 1973. The announced collapse of Herstatt Bank under the weight of massive currency losses occurred in June 1974. In June of 1977, U.S. official statements asserting a need for a balance of payments correction was interpreted as intent to depreciate the dollar, which fell broadly and sharply over the ensuing year and a half. Iraq invaded Kuwait in August 1990, and a failed coup in the Soviet Union to topple Chairman Gorbachev happened one year later. The Asian debt crisis began on July 1, 1997, triggered by the Thai baht devaluation, and the subprime debt crisis surfaced ten years later in August 2007. British voters in June 2016 chose narrowly to leave the European Union.
Meaningful currency movement in summer can be less representative of economic fundamentals than at other times of the year. The dollar’s directional change between Memorial Day and Labor Day was different in sign from its calendar yearend-to-yearend change in 2000, 2001, 2004, 2007, 2008, 2009, 2012, 2013, 2015, and 2018.
The dominant questions coming into the summer of 2021 concern how central bankers might respond to this year’s spike in inflation. How long will inflation remain elevated? At what level and when might inflation crest? Will inflation settle back as quickly as such has accelerated or will the dissipation of price pressure prove rather sticky? Will the rise in prices be a story about shifting relative prices concentrated in areas facing supply shortages related to the pandemic, or will inflation spread more generally to all areas of the economy and involve wages, too?
Central bankers around the world have mostly adopted a patient approach. The rhetoric of Fed officials is similar to comments from officials at other central banks. The message is patience and much greater concern about reining in stimulus too soon than too late. Will the guidance from different central banks stay in lock-step, or will expressed reaction functions become more differentiated? Does the fact that America’s recovery from pandemic is evolving sooner and more quickly than those of other developed economies imply that patience might be ditched faster by the Fed than elsewhere? Even if that doesn’t happen, might long-term interest rate differentials evolve in a way that enhances U.S. premiums because investors expect the Fed to lose patience?
U.S. inflation has waxed and waned more often since the 2008-09 recession that generally realized. Aside from the fact that the current spike in price pressure has been linked to a once-in-a-century public health emergency, the fact that inflation oscillated noticeably and frequently even before Covid suggests that Fed officials are being authentic in preaching patience. Here’s the record: year-on-year consumer price inflation swung from -2.1% in July 2009 to +2.7% five months later, then fell to 1.1% by mid-2010, only to accelerate to 3.9% in September 2011. Ten months after that, inflation was down to 1.4%, and a rise to 2.0% by June 2014 was followed by a dip through zero percent to -0.2% in April 2015. In 2017, inflation dropped from 2.7% in February to 1.3% in June. In 2018, it rose as high as 3.2% at midyear but then fell to 1.5% by February 2019. A rise to 2.4% in September that year was reversed by the Covid recession that saw inflation drop to 1.2% in May 2020.
All of the above gyrations underscore the need for monetary authorities to look through the noise and focus upon long-term developments. Since the Fed Chairmanship of Paul Volcker in the 1980s, the Fed’s forecasts of future inflation have erred on the side of being too high far more frequently than being too low, and officials at this critical point in the business cycle will need to double-down from making the mistake of seeing the ghost of inflation at every turn.
In the periods between Memorial Day and Labor Day over the past five years, there has been a large net movement in the dollar against either the euro or yen on only three of the ten occasions. In each case, the dollar fell. A 6.6% drop against the yen in the summer of 2016 was the only instance to involve Japan’s currency. Against the euro, the dollar fell 8.1% last summer and 5.8% in the summer of 2017. Four of the other seven dollar changes in summer were drops of 0.4% against the euro in 2016 and of 1.2% in 2020, 3.1% in 2019, and 0.8% in 2017 against the yen. The dollar rose 1.3% in 2019 and 0.5% in 2018 against the euro and gained 0.8% against the yen in 2018.
An interesting finding to emerge in this research was the tight shot group of the EUR/USD relationship at Memorial Day in the past five years: 111.4 in 2016, 112.2 in 2017, 111.8 in 2019, and 109.0 last year. The exception from this pattern — 117.1 in 2018 — showed a weaker dollar and one much closer to the euro’s current value than in the other four years. The dollar has shed some of its safe-haven support as economies have opened. One doesn’t get the sense, however, that investors are worried that the Fed will do a worse job than other central banks of preventing inflation from becoming too excessive. When that happened in the 1970’s, the dollar suffered some substantial losses.
Copyright 2021, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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