Almost one month has passed since the Bank of Japan (BOJ) intervened in forex markets on behalf of the Japanese Yen. In one trading session, it spent a record 2.1249 trillion yen ($25.37 billion) to obtain a 3.5% jump in the Yen. Since then, the Yen has continued to appreciate, and now it seems like it’s only a matter of time before the BOJ intervenes again…and again and again.
Prior to intervening, Japan’s main concern was that there would be a bitter backlash from the rest of the world. On the one hand, Japan’s fears were validated by accusations that it was engaging in “currency war.” It also received a mild rebuke from US policymakers, who fretted that its intervention would cause China to reconsider allowing the Yuan to appreciate.
Others were more forgiving, however, going so far as to excuse Japan’s actions as a necessary response to Korean and Chinese intervention. After all, given that Japan competes directly with these two countries for export market share, how could it sit by idly as they actively devalued their currencies. US Treasury Secretary Timothy Geithner let Japan completely off the hook by telling reporters that he didn’t think Japan “set the fire”for the current dynamic in forex markets.
Deutsche Bank added, “It must be frustrating for Japanese policymakers to see other Asian economics getting away with such persistent intervention to weaken their currencies. Perhaps the final straw was the Chinese purchases of JGBs [Japanese government Bonds] which some Japanese officials argue played a prominent role in the recent JPY appreciation.” In other words, not only was China holding down its currency against the Dollar, but now it had started to target the CNY/JPY exchange rate.
At next week’s G7 meeting, Japan will try to achieve a formal permission slip for its program, by arguing that, ” ‘Our intervention isn’t the kind of large-scale operations that aim to achieve certain rate levels over the long term.’ September’s intervention was only ‘aimed at curbing excess fluctuations’ in the yen’s rates.” Depending on how the G7 responds (via its official statement), it may influence the likelihood of further intervention.
From an economic standpoint, Japan also doesn’t have much to fear. The only downside from printing money wholesale and using it to buy US Dollars is the risk of inflation. In Japan, however, this would be seen as a positive development, and is hardly a constraint to further intervention: “With Japan’s economy still in the grip of deflation, the authorities have the ability and the incentive to prevent further gains in the yen.” In fact, the Bank of Japan recently “slashed its overnight ratetarget to virtually zero and pledged to purchase 5 trillion yen ($60 billion) worth of assets in a fresh dose of economic stimulus.” As the Fed prepares to do the same [more on that later this week], the BOJ’s hope is that this time around, “The yen won’t be reflexively favoured by investors turning bearish on the greenback.”
Really, then, the only question is when the BOJ will intervene. The Japanese Yen has already fallen below 82 USD/JPY, disappointing analysts that predicted the point of intervention would take place at 83/84, near the point of last month’s intervention. That it has allowed the Yen to continue to slide is somewhat baffling in that it exposes the futility of its previous efforts. The BOJ claims that it isn’t embarking on a program on continuous intervention, but this is really the only chance it has of being successful for any length of time. The Swiss National Bank (SNB) established a “line in the sand” of 1.50 EUR/SWF and spent $200 Billion defending it. Where is the the BOJ “line in the sand?” 82? 80?
In theory, this should mean that the Japanese Yen appreciation will soon come to an end. Given the fact that every other major currency (with the exception of the Euro) is being either indirectly or competitively devalued, however, this is far from certain. If Japan is serious about holding down the Yen, it may have to formally declare war.
Saturday, October 23, 2010
Brazilian Real at 2-Year High Despite “Currency War”
Brazil is beating the drumbeat of war. The forex variety, that is. According to the Finance Minister, “We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.” By its own admission, Brazil will not be sitting on the sidelines of this war. Rather, it will do battle on behalf of its currency, the Real.
Brazil’s concerns are perhaps justified, since the Brazilian Real has surged to a 2-year high, and is amazingly not worth more than prior to the collapse of the Lehman Brothers and the ignition of the global financial crisis. (If anything, this shows just how far we’ve come in returning to stability). According to Goldman Sachs, the Real is now the most overvalued major currency in the world. This is confirmed by The Economist’s Big Mac Index, which shows that in Purchasing Power Parity (PPP) terms, Brazil is now the third most expensive country in the world, behind only Norway and Switzerland.
It’s not hard to understand why the Real is soaring. Its benchmark Selic rate is 10.75%, with government bonds yielding an even higher 12%. Even after controlling inflation, this is the highest among major currencies. Its economy is booming; GDP is projected at 10% in 2010. As a result, capital flow inflows have returned to pre-credit crisis levels: “Net foreign-exchange inflows totaled $11.14 billion in the September 1-17 period, up from $2.11 billion in the first 10 days of the month, according to data released Tuesday by the country’s central bank.” The inflows have been driven by a $70 Billion stock offering by PetroBras, the (formerly) state-owned oil company. It is a record sum, and over 3 times bigger than the eye-popping $23 Billion the Agricultural Bank of China raised only a few months ago. “If the Petrobras deal had never happened, the real might currently be trading somewhere around 1.75 per dollar,” compared to 1.70 today. With other companies rushing to follow suit with debt and equity offerings, cash will probably continue to pour in.
As I said at the beginning of this post, the Bank of Brazil has several tools up its sleeve. It has already resumed “surprise daily auctions to buy excess dollars in the spot market” (suspended in 2006), in which investors can trade Dollars for Brazilian government debt. It is also proposing reverse currency swaps, which would serve a similar purpose. ” ‘The order is to buy, buy and buy,’ ” said a government source. It has purchased nearly $1 Billion in foreign currency in the month of September alone, and has pledged to deploy its $10 Billion Sovereign investment fund if necessary. Finally, there is talk of raising the tax rate (currently 2%) on all foreign capital inflows, though there is no real timetable for such a move.
Alas, while the government of Brazil is certainly sincere in its intentions to hold down the Real, it lacks the wherewithal. Its $1 Billion intervention in September was dwarfed by the $20+ Billion spent by the Bank of Japan in one day to hold down the Yen. Even controlling for the difference in the size of their respective economies, Brazil has still been thoroughly outspent. Its $10 Billion investment fund pales in comparison to the ~$1 Trillion forex reserves of Japan. In short, Brazil would be wise to avoid full-fledged engagement in currency war.
Besides, the Real strength can better be seen in terms of weakness in the US Dollar and other G4 currencies. In this regard, Brazil’s measly purchases of US Dollars on the spot market probably won’t do much to counter the gradual exodus of cash from safe-havens back into growth currencies. Perhaps, it can take solace in the fact that the Real is so overvalued that it would seem to have no place to go but down.
Betting on China Via Australia
There are plenty of investors that think betting on China is as close to a sure thing as there could possibly be. The only problem is that investing directly in China’s economic freight train is complicated, opaque, and sometimes impossible. The Chinese government maintains strict capital controls, prohibits foreigners from directly owning certain types of investment vehicles, and prevents the Chinese Yuan from appreciating too quickly, if at all. For those that want exposure to China without all of the attendant risks, there is a neat alternative: the Australian Dollar (AUD).
Those of you that regularly read my posts and/or follow the forex markets closely should be aware of the many correlations that exist between currencies and other financial markets, as well as between currencies. In this case, there would appear to be a strong correlation between Chinese economic growth and the Australian Dollar. If the Chinese Yuan were able to float freely, it might rise and fall in line with the AUD. Since the Yuan is fixed to the US Dollar, however, we must look for a more roundabout connection. HSBC research analysts used Chinese electricity consumption as a proxy for Chinese economic activity (why they didn’t just use GDP is still unclear to me), and discovered that it fluctuated in perfect accordance with the Australian Dollar.
Before I get ahead of myself, I want to explain why one would even posit a connection between China and the Aussie in the first place. There are actually a few reasons. First, Australia is economically part of Asia: “Today, 43 per cent of Australia’s total merchandise trade is with north Asia. A further 15 per cent is with Southeast Asia.” Second, Australia’s economy is driven by the extraction and sale of natural resources, of which China is a major buyer and investor: “In 2008-9, China was the biggest investor in the key resource sector with $26.3bn involvements approved, 30 per cent of the total.” Third, Chinese demand has come to dictate the prices of many such resources, causing them to rise continuously. Thus, Australia’s natural resource exports to countries other than China still draw strength (via high commodity prices) from Chinese demand.
As one analyst summarized, “China is buying raw materials from Australia in leaps and bounds, and that’s what’s driving that currency’s growth.” Sounds like an Open and Shut case. In fact, this presumed correlation has become so entrenched that any indication that China is trying to cool its own economy almost always prompts a reaction in the Aussie. To be sure, warnings that China’s annual legislative conference (scheduled for October 17) would produce a consensus call for a tightening of economic policy have made some forecasters more conservative. Still, as long as the Chinese economy remains strong, the Australian Dollar should follow.
It’s worth pointing out that the correlation between the Aussie and the Chinese economy doesn’t exist in a vacuum. For example, the Australian Dollar has also closely mirrored the S&P 500 over the last decade, which suggests that global economic growth (and higher commodity prices) are as much of a factor in the Aussie’s appreciation as is Chinese economic activity. The Aussie is also vulnerable to a decline in risk appetite, like the kind that took place during the financial crisis and flared up again as a result of the EU Sovereign debt crisis. During such periods, Chinese demand for commodities becomes irrelevant.
On the other hand, part of the reason the Australian Dollar has surged 10% since September and 20% since June is because other countries’ Central Banks (such as China) have increased their interventions on behalf of their respective currencies. Australia is one of a handful of countries whose Central Bank not only hasn’t actively tried to depress its currency, but whose monetary policy (via interest rate hikes) actually invites further appreciation. As the Aussie closes in on parity and Australian exporters and tourism operators become more vocal about the impact on business, however, the Reserve Bank of Australia (RBA) might be forced to act.
RMB Appreciation Accelerates, but Dollar Peg Remains in Place
The Chinese Yuan has touched a new high, at 6.69 USD/CNY. Given that the Yuan has still only risen about 2% since the peg was officially loosened in June - with most of that appreciation taking place in the last couple weeks – there still remains intense pressure on China to do more.
Last week’s intervention by the Bank of Japan diverted a tremendous amount of attention towards the Yuan. In fact, many analysts have argued that it is only because of the Yuan-Dollar peg (itself, as well as the Chinese purchases of Yen assets that it engendered) that Japan was forced to act: ” ‘Countries see that getting involved in currency manipulation is a way to give themselves an advantage’…’China, their actions affected Japan, and Japan is affecting us.’ ” The Yen intervention could also force the G20 to re-focus its attention on the Yuan, and at least devote some discussion to it at the next summit.
It should be noted that the two soundbites above both emanated from US Congressmen, which is important because the US government is currently mulling action on the Yuan currency peg. Politicians are growing tired by the Treasury Department’s repeated failure to call China a “Currency Manipulator,” which would require diplomatic talks and even trade sanctions. The Treasury will have an opportunity redeem itself in its next report on foreign exchange, due out on October 15, but it is expected that the report will either be delayed or released without adequately addressing the undervalued Yuan.
In fact, Treasury Secretary Geithner testified before Congress last week, and at least admitted that something needed to be done: “The pace of appreciation has been too slow and the extent of appreciation too limited. We have to figure out ways to change behavior.” However, this was only in response to acerbic criticism – (Senator Schumer told him, “I’m increasingly coming to the view that the only person in this room who believes China is not manipulating its currency is you.”) – and he ultimately failed to outline a timetable/blueprint for action. Despite the consensus among politicians (and President Obama) that the currency peg is harmful to the US economy, Geithner made it clear that the Treasury Department continues to favor unilateral action towards dealing with problem, without Congressional intervention. For now, then, politicians are probably relegated to saber-rattling and name-calling.
China’s response to this charade has been predictable. Trade representatives hinted that China wouldn’t bow to external pressure, and that any attempt at “punishment” would be met with countervailing actions. China also questioned the economics between arguments that the Dollar peg contributes to trade imbalance, calling such claims “groundless.” This position is actually supported by the notion that while the Yuan appreciated by 20% against the Dollar from 2005-2008, the US/China trade deficit actually widened.
In practice, China is likely to stick to its policy of gradual Yuan appreciation, or a few reasons. First of all, while Chinese policymakers know that they don’t need to wholly appease US politicians, they at least need to pretend that they are listening. It’s true that the US is dependent on Chinese products and its purchases of Treasury Bonds. However, it is arguably just as dependent on the US to buy its exports, which promotes employment and social stability, and it is keen to avoid a trade war if possible.
Second, a long-term appreciation of the RMB is actually in China’s best interest. If it wants to spur domestic consumption and promote more value-added manufacturing, it will need a more valuable currency. Outbound M&A, especially involving natural resource companies, will also be more economical if the Yuan is worth more. Also, if China has any serious ambitions of turning the Yuan into a global reserve currency, it will need to create capital markets that are deeper and more liquid, which it is currently unmotivated to do, lest it spur demand for Yuan by foreign institutional investors.
Finally, China should let the Yuan appreciate because it is financially gainful to do so. As I mentioned above, its trade surplus with the US has widened over the last few years as prices for its exports grow along with quantity. Meanwhile, prices for imports and prices paid for commodities and other natural resources have declined in Yuan-terms. For that reason, I think China will probably continue to stick its current policy, and allow the RMB to continue to slowly inch up.
Friday, October 22, 2010
Passive Currency Investing Rises in Popularity
Those who read the most recent Bank of International Settlements (BIS) Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity know that daily forex turnover rose 20% over the last three years, to $4 Trillion. According to the official data, the vast majority of participants are financial institutions and the like, which would give the impression that overwhelming majority of trading is engaged in for speculative purposes. Anecdotal research, however, suggests that behind the scenes, it is “passive” foreign exchange trading that is making its presence known.
“According to Deutsche Bank, ‘passive’ players – such as corporate treasurers who are looking to hedge currency risk or to facilitate their core business, not to make a profit – account for more than 50 per cent of currency flows.” By definition, these passive players are not out to make a profit, and exchange currencies only because it is necessary to simply conduct business.
This is not surprising since the number of confirmed exporters in the US rose 10% during the last year for which data is available. It is almost a given that the number of exporters in emerging markets is increasing an an even faster clip. As a result, corporate banking departments are fighting to keep up with demand for currency exchange/hedging by such businesses, which simply want the ability to know their own profit margins in advance, and can set prices accordingly. Big corporations are among the most reliable hedgers: “Companies lifted the amount of estimated 12-month forward earnings hedged to 34.3 percent on average in September…boosted by a 22 percentage point rise in the U.S. corporations’ hedge ratio to 55.7 percent, the highest on record.” Even Sovereign Wealth funds are reportedly interested in hedging their forex reserves.
If not for the enormous pool of passive participation in forex, it might be difficult for speculators to turn a profit. ” ‘The flows from passive players have only limited direct sensitivity to broader market and macro factors, so they can serve as counterparts to investment theme-driven flows,’ ” reports the Financial Times. Since these participants are disinterested in actual forex fluctuations – so long as they can lock in exchange rates using spot and futures transactions – it creates passive momentum for currency movement, and hence opportunities for speculators (including retail forex traders) to turn a profit.
In some ways, this is a free lunch to speculators. On the one hand, double-digit currency moves have become so common over the last few years as to become almost mundane, with some currencies routinely rising or falling by more than 5% a month. On the other hand, forex volatility has fallen over time (except during the financial crisis) and is lower compared to other asset classes. For example, “Annualised average daily volatility of the euro/dollar pair over the past decade, for example, is 140 per cent lower than the volatility in the EuroStoxx 50 over the same period.” In addition, “JPMorgan’s index of implied volatility on options for Group of Seven currencies dropped 13 percent in the third quarter, after jumping 22 percent in the prior three months.” This is amazing, since it implies that as uncertainty has risen, risk (aka volatility) has fallen.
Interest in forex is also rising among indirect investors, such as pension funds, mutual funds, and retail investors that seek exposure to currency through investment products. “In July, RBC Capital Markets published a survey of 102 asset managers…which revealed that 38 per cent say currency tops the list of asset classes they are most likely to move into over the next 12 months, ahead of equities and commodities.” On a related note, most investment advisers recommend that currencies should comprise 2-7% of every investment portfolio, regardless of objective and tolerance to risk. The number of forex investment “specialists” and related investment products appear to be rising to meet demand variously based on carry, momentum and value strategies.
At this rate, it looks like forex volume will set a fresh record in 2013, when the next round of data is released.
QE2 Weighs on Dollar
In a few weeks, the US could overtake China as the world’s biggest currency manipulator. Don’t get me wrong: I’m not predicting that the US will officially enter the global currency war. However, I think that the expansion of the Federal Reserve Bank’s quantitative easing program (dubbed QE2 by investors) will exert the same negative impact on the Dollar as if the US had followed China and intervened directly in the forex markets.
For the last month or so, markets have been bracing for QE2. At this point it is seen as a near certainty, with a Reuters poll showing that all 52 analysts that were surveyed believe that is inevitable. On Friday, Ben Bernanke eliminated any remaining doubts, when he declared that, “There would appear — all else being equal — to be a case for further action.” At this point, it is only a question of scope, with markets estimates ranging from $500 Billion to $2 Trillion. That would bring the total Quantitative Easing to perhaps $3 Trillion, exceeding China’s $2.65 Trillion foreign exchange reserves, and earning the distinction of being the largest, sustained currency intervention in the world.
The Fed is faced with the quandary that its initial Quantitative Easing Program did not significantly stimulate the economy. It brought liquidity to the credit and financial markets – spurring higher asset prices – but this didn’t translate into business and consumer spending. Thus, the Fed is planning to double down on its bet, comforted by low inflation (currently at a 50 year low) and a stable balance sheet. In other words, it feels it has nothing to lose.
Unfortunately, it’s hard to find anyone who seriously believes that QE2 will have a positive impact on the economy. Most expect that it will buoy the financial markets (commodities and stocks), but will achieve little if anything else: “The actual problem with the economy is a lack of consumer demand, not the availability of bank loans, mortgage interest rates, or large amounts of cash held by corporations. Providing more liquidity for the financial system through QE2 won’t fix consumer balance sheets or unemployment.” The Fed is hoping that higher expectations for inflation (already reflected in lower bond prices) and low yields will spur consumers and corporations into action. Of course, it is also hopeful that a cheaper Dollar will drive GDP by narrowing the trade imbalance.
At the very least, we can almost guarantee that QE2 will continue to push the Dollar down. For comparison’s sake, consider that after the Fed announced its first Quantitative Easing plan, the Dollar fell 14% against the Euro in only a couple months. This time around, it has fallen for five weeks in a row, and the Fed hasn’t even formally unveiled QE2! It has fallen 13% on a trade-weighted basis, 14% against the Euro, to parity against the Australian and Canadian Dollars, and recently touched a 15-year low against the Yen, in spite of Japan’s equally loose monetary policy.
If the Dollar continues to fall, we could see a coordinated intervention by the rest of the world. Already, many countries’ Central Banks have entered the markets to try to achieve such an outcome. Individually, their efforts will prove fruitless, since the Fed has much deeper pockets. As one commentator summarized, It’s now becoming “awfully hypocritical for American officials to label the Chinese as currency manipulators? They are, but they’re not alone.”
Emerging Market “Wall of Money” Spurs Currency War
According to Goldman Sachs (which if nothing else, is good at characterizing financial trends. Remember “BRIC?”), there is a “Wall of Money” that is already flooding emerging markets and will continue to do so for the foreseeable future.
“The Institute of International Finance projected 2010 capital flows of $825 billion, up from $581 billion in 2009 and from the $709 billion that the trade group for global financial-services firms had projected for 2010 in April.” In hindsight, the outflow of capital from emerging markets that took place during the financial crisis will probably look like a blip, as risk appetite has already recovered to pre-crisis levels, and then some!
“The move into emerging markets has been led by stock investors, who will pour an estimated $186 billion into these countries this year, — fully three times the annual average of $62 billion generated between 2005 and 2009.” Emerging Market Bond funds, meanwhile, now routinely receive more than $1 Billion per week. Sovereign wealth funds are also starting to shift some of their assets into emerging market assets/currencies as part of their respective diversification strategies. As you can see from the chart below (courtesy of The Economist), Asia is by far the largest recipient of investment, followed by Latin America.
The continued shift of capital from the industrialized world into emerging markets as being driven both by economic fundamentals and the desire to earn a greater return on investment. “The IMF forecast this month that developing nations will expand 6.4 percent next year, outstripping growth of 2.2 percent among advanced economies.” Meanwhile, the ratio of foreign debt to GDP among developing nations has been cut to 26 percent, compared to 41 percent in 1999. And yet, even as analysts predict that emerging markets will account for 85% of global growth going forward, “emerging markets account for $3 trillion, or only 15 percent of market capitalisation of the benchmark MSCI world index.”
While it’s understandable, then, that investors would want to rectify this imbalance as quickly as possible, they need to realize that developing countries’ capital markets simply aren’t deep enough to absorb all of the incoming capital. In other words, an limited pool of capital is chasing a limited stock of accessible investments, and the result is that asset prices and exchange rates are climbing inexorably higher.
Analysts argue, “Some appreciation is due: a rise against rich-world currencies is both a natural consequence of the faster growth of emerging economies and a way to correct global imbalances.” But a 50% rise over five years (notched by a handful of currencies) does not represent some appreciation, but rather an explosion. This is precisely the sentiment echoed by many of the emerging markets, themselves, which have taken to using guerilla tactics to hold down their currencies. Since the latest phase of the “currency war” was ignited by Japan in September, every week has led to increasingly far-flung countries – Peru, Chile, Czech Republic, Poland, South Africa – reputedly contemplating intervention.
According to an interesting economic analysis, which scaled intervention to the size of the given country’s monetary base, South Korea and Taiwan have been among the most active participants in forex markets, while Thailand and Malaysia have been among the most restrained. This is born out by the sizable appreciation of both the Thai Baht and Malaysian Ringit over the last few years. However, I wonder if some economists will take issue with their assessment that Brazil and China have been relatively modest interveners.
Of course, this doesn’t make it any easier to forecast, since how a country behaved in the past isn’t necessarily indicative of how it will behave in the future. For example, Thailand just announced that it will not intervene, but Brazil will double its forex tax from 2% to 4%. Case in Point!
Korean Won Rises Despite Currency War
The Bank of Korea is one of the major participants in the ongoing global currency war, intervening on behalf of the Won to the tune of $1 Billion per day! Meanwhile, the Korean Won has risen 5% in the last month, and 10% over the last three months, the highest in Asia. What a disconnect!
First of all, what’s behind the Korean Won’s rise? In a word, everything. At the moment, things couldn’t be going any better for the Korea Won. The economy is booming. The current account / trade surplus is on pace to surpass forecasts. The Central Bank has hiked its benchmark interest rate once already to 2.25%, and will probably hike again this month. In addition. even though Korean indebtedness is rising, “It is ranked 99th among 129 nations in terms of the ratio of public debt to the gross domestic product (GDP), which means the country’s balance sheet is healthier than most other nations in the world.” Added another analyst, “In this period where there’s a lot of concern about debtor nations, countries that are considered to have higher credit scores will benefit.”
While the Korean stock market has surged (13% this ear and 50% last year), it still remains 25% below its 2007 peak and is trading at valuations well below other Asian countries. It’s no wonder that foreign investors have been net buyers of Korean stocks: “Foreigners have bought more Korean shares than they sold every day for four weeks and net purchases for the year amount to some $13 billion.” It doesn’t hurt investors that the currency is appreciating and that interest rates are rising; at the moment, there really isn’t much downside from investing in Korea.
Meanwhile, the US (Federal Reserve Bank) is contemplating an expansion of its quantitative easing program, and other Central Banks may follow suit. Under the (now fading) paradigm of risk aversion, concerns of economic decline in the industrialized world would have been accompanied by a sell-off in emerging markets and capital flight to safe havens. As evidenced by the spike in the Korean Won and other emerging market currencies, such is no longer the case.
Enter the Bank of Korea (BOK). It is widely known that the South Korean economy is highly dependent on exports, which could be negatively impacted by a rising currency: “For every one percent gain of the won against the U.S. dollar, the nation’s export and gross domestic product decreases by 0.05 percent and 0.07 percent each.” Moreover, South Korea competes directly with Japan, which means the KRW-JPY exchange rate is of crucial importance to the Bank of Korea. Of course, both currencies had been appreciating at a similar clip. Once the Bank of Japan intervened, however, the BOK had no choice bu to double-down on its own efforts.
The Bank of Korea seems to appreciate that there is only so much it can do. Intervention is not cheap, and its foreign exchange reserves have since surged to $290 Billion. It is also not very effective, and the Korean Won has continued to rise. Finally, the currency intervention contradicts the BOK’s efforts to contain rising prices. By not raising interest rates and trying to hold its currency down, it risks stoking inflation. What’s more – South Korea is actually hosting this week’s G20 summit, at which currency intervention is expected to be a major topic of discussion. It would be awkward, to say the least, if Korea’s own currency intervention was broached.
Thus, it seems the Korean Won is destined to keep rising. It, too, is well below its 2007 peak, and there is scope for further appreciation. The BOK will continue to make token attempts at halting its rise, but at this point, the forces that is fighting against – bullish investors and other Central Banks – are too great.
Currency War: Who are the Winners and Losers?
On September 27, Brazilian Finance Minister, Guido Montega, used the term “currency war” to describe the series of recent Central Bank interventions in forex markets. While he may not have intended it, the term stuck, and financial journalists everywhere have run wild with it.
In the current cycle (dating back a couple years), more than a dozen Central Banks have entered the forex markets with the intention of holding down their respective currencies, both against each other and also against the US Dollar. What makes it a war is that the Central Banks are fighting to outspend and outdo each other. It is a War of Attrition, in that Central Banks will fight until they’ve exhausted all of their wherewithal, conceding defeat for their currencies. On the other hand, unlike in a conventional war, there aren’t any alliances, nor is there much in the way of little strategy. Central Banks simply buy large blocks of counter currencies and hope their own currencies will then depreciate on the spot market. In addition, since the counter currencies are almost always Dollars and/or Euros, the participants in this war are not even competing directly against each other, but rather against an enemy that isn’t doing much to fight back. [Chart belowcourtesy of Der Spiegel].
The Swiss National Bank (SNB) was the first to intervene, and staged a one-year campaign over the course of 2009 to hold the Swiss Franc at 1.50 against the Euro. Ultimately, it failed when the sovereign debt crisis caused an exodus of Euro selling. The Bank of Brazil was next, although its interventions havebeen more modest; it seems to have accepted the ultimate futility of its efforts, and will seek to slow the Real’s appreciation rather than halt it. Last month, the Bank of Japan spent $20 Billion in one session in order to show the markets how serious it is about fighting the Yen’s rise. In fact, it was this intervention that sparked Montega’s comments about currency war. (The BOJ hasn’t intervened since). All along, the People’s Bank of China has continued to add to its war chest of reserves – currently $2.5 Trillion – as part of the ongoing Yuan-Dollar peg. And of course, there have been a handful of smaller interventions (South Korea, Singapore, Taiwan) and no shortage of rhetorical (Canada, South Africa) interventions, as well as indirect (US, UK) intervention.
That’s right- don’t forget that the Fed and the Bank of England, through their respective quantitative easing programs, have injected Trillions into the financial markets and caused their currencies to weaken. In a sense, all of the subsequent interventions have been effected in order to restore the equilibrium in the currency markets that was lost when these two Central Banks deflated there currencies through wholesale money printing. Since much of this cash has found its way into emerging markets (See chart below), you can’t blame their Central Banks from trying to soften some of the upward pressure on their currencies.
It’s still too early too early to say how far the currency war will go. The G7/G20 has announced that it will address the issue at its next summit, though it probably won’t lead to much in the way of action. Ultimately, politicians can’t do much more than shake their fingers at countries that try to hold down their currencies. In the case of the Yuan-Dollar peg, American politicians have tried to take this one step further by threatening to slap China with punitive trade sanctions, but this probably won’t come to pass and may disappear as an issue altogether after the November elections. As I reported on Friday, Brazil has taken matters into its own hands by taxing all foreign capital inflows, but this hasn’t had much effect on the Real.
That brings me to my final point, which is that all currency intervention is futile in the long term, because most Central Banks have limited capacity to intervene. If they print too much money to hold down their currencies, they risk stoking inflation. Of course China is the exception to this rule, but this is less because of the size of its war chest and more because of the mechanics of its exchange rate regime. For Central Banks to successfully manipulate their currencies on the spot market, they must fight against the Trillions of Dollars in daily forex turnover. Eventually, every Central Bank must reckon with this truism.
In terms of identifying the winners and losers of the currency war (as I promised to do in the title of this post, the Euro will probably lose (read: appreciate) because the ECB is not willing to participate. The same goes for the Swiss Franc, since the SNB has basically forsaken currency intervention for the time being. The Bank of Japan has deep pockets, and if the markets push the Yen back up above 85 Yen/Dollar, I wouldn’t be surprised to see it intervene again. With the Fed mulling an expansion of its quantitative easing program, meanwhile, the Dollar will probably continue to sink. And as for the countries that are doing the actual intervening, they might succeed in temporarily holding down the valuer of their respective currencies. As capital shifts to emerging markets over the long-term, however, their currencies will soon resume rising.
Thursday, October 21, 2010
Bullish on the Euro?
Wouldn’t life just be a little easier if the EUR/USD, the most important forex pair and bellwether of currency markets, could simply pick a direction and stick to it. It dove during the financial crisis, only to surge during the apparent recovery phase, fell during the sovereign debt crisis, and rose during the paradigm shift, then fell as risk appetite waned, only to rise again in September, en route to a 5-month high.
There are a handful of factors which currently underlie the Euro’s strength, which can all generally be explained by the fact that risk is “on” at the moment, and the markets are moving away from so-called safe haven currencies and back towards growth investments. Of course that could change tomorrow (or even 5 minutes from now!), but at the moment, risk appetite is high and the Euro symbolizes risk. Never mind how ironic it is, that growth in the EU is projected at 1.8% for the year while Rest of World (ROW) GDP will probably top 5%. All that matters is compared to the Dollar (and Yen, Pound, Franc to a lesser extent) the Euro is perceived as the currency of risk.
The Euro’s cause is also helped by the ongoing “currency wars,” which heated up last week with Japan’s entry into the game. Basically, Central Banks around the world are now competing with each other to devalue their currencies. In contrast, the European Central Bank (ECB) has decided to remain on the sidelines (in favor of fiscal austerity), which is forcing the Euro up (or rather all other currencies down). To make matters even worse, “The U.S. Federal Reserve indicated this summer that it may ease monetary policy further… often seen as printing money to pump up the economy.” As a result, “The euro looks set to keep on climbing in a trend that looks increasingly entrenched.”
There are certainly those that argue that the Euro’s recent surge reflects renewed confidence in the Eurozone economy and prospects for resolving the EU debt crisis. After all, most Euro members will reduce their budget deficits in 2010 and auctions of new bonds are once again oversubscribed. On the other hand, interest rates for the PIGS (Portugal, Italy, Greece, and Spain) have risen to multi-year highs, as investors are finally trying to make a serious effort at pricing the possibility of default.
In addition, the credit markets in the EU are barely functioning, and large institutions remain dependent on the ECB’s credit facilities for financing. Finally, it shouldn’t be forgotten that the only reason crisis was due to the massive support (€140 Billion) extended to Greece. When this program expires in less than three years, the fiscal problems of Greece (and the other PIGS) will be exposed once again, and a new (stopgap) solution will need to be proposed.
As every analyst has pointed out, none of the EU’s fiscal problems have been solved. EU members have certainly proven adept at resolving acute crises and the ECB certainly deserves credit for keeping credit markets functioning, but none has proposed a viable solution for repairing of member countries’ fiscal and economic health. Currency devaluation is impossible. Sovereign default is being prevented. That leaves wage cuts and increased productivity as the only two paths to equilibrium. The former could be accomplished through inflation, but the ECB seems reluctant to allow this to happen.
For better or worse, the EU seems to have pushed these problems down the road, and if all goes according to plan, they won’t need to be revisited for 2-3 years. For now, then, the Euro is probably safe, and may even thrive. Short positions in the Euro are being unwound with furious speed and data indicate that there is still plenty of scope for further unwinding. Inflation remains subdued, economic growth is stable, and the ECB so far hasn’t voiced any disapproval of the Euro’s rise. While I promote this bullishness with the caveat that “traders have shown a willingness to smack the euro lower from time to time on the slightest news or rumor of downgrades to euro-zone sovereign or bank ratings,” the general Euro trend is now unquestionably UP.
GBP/USD - Respect of Uptrend
Price action on GBP/USD (a 4-hour chart of which is shown) as of Wednesday (10/06/2010) has been adhering to a rough parallel uptrend channel since mid-September after pivoting off the lows around 1.5300 in early September. Within this uptrend channel, a clear upside resistance target currently resides in the key 1.6000 price region. For more technical analysis on this currency pair, please click here for Wednesday’s (10/06/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
GBP/USD - Bullish Trend Continuation
Price action on GBP/USD (a 4-hour chart of which is shown) as of Friday (10/08/2010) has continued to adhere to a parallel uptrend channel extending back to the September lows around 1.5300. Price has just bounced up off the bottom of the channel on Friday, after having reached and slightly surpassed its original 1.6000 resistance target and then retreating on Thursday. For more technical analysis on this currency pair, please click here for Friday’s (10/08/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
USD/CHF - Retracement within Strong Bearish Trend
Price action on USD/CHF (a 4-hour chart of which is shown) as of Monday (10/11/2010) has made a minor bullish retracement after hitting an all-time low of 0.9554 late last week. This occurs within the context of an exceptionally steep downtrend that has characterized this pair since the high above 1.1700 in early June. Currently, price is still under key 0.9700 resistance. For more technical analysis on this currency pair, please click here for Monday’s (10/11/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
AUD/USD - Approach of Parity then Retreat
Price action on AUD/USD (a 4-hour chart of which is shown) as of Thursday (10/14/2010) broke out above 0.9900 resistance to reach a record high just shy of parity (1.0000) in early Thursday trading, before pulling back to re-test the point of breakout. This occurs within a strong and accelerated uptrend extending back to late August. For more technical analysis on this currency pair, please click here for Thursday’s (10/14/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
EUR/USD - Retreat From 1.40 But Still Bullish
Price action on EUR/USD (a 4-hour chart of which is shown) as of Wednesday (10/13/2010) has tried but thus far failed to rise above key 1.4000 resistance after bouncing up off 1.3800 support on Tuesday. Early Wednesday trading saw price action rise all the way up to hit 1.4000 right on the figure before retreating. For more technical analysis on this currency pair, please click here for Wednesday’s (10/13/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
Wednesday, October 20, 2010
EUR/USD - Hits 1.4000 Target and Retreats
Price action on EUR/USD (a 4-hour chart of which is shown) as of Thursday (10/07/2010) has risen substantially from its 1.3800 resistance breakout point to reach and slightly surpass its 1.4000 target before retreating, establishing a fresh 8-month high in the process. This occurs within the context of a steep uptrend channel that has characterized this pair since the September low around 1.2650. The current directional bias, in line with the strong bullish trend, continues to be to the upside. For more technical analysis on this currency pair, please click here for Thursday’s (10/07/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
USD/CAD - Bearish Bias Within Steep Downtrend
Price action on USD/CAD (a daily chart of which is shown) as of Friday (10/15/2010) has shown some bullish correctiveness today after hitting parity (1.0000) on Thursday, but overall the pair still appears biased to the downside in line with the steep downtrend. For more technical analysis on this currency pair, please click here for Friday’s (10/15/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
EUR/USD - Bullishness Breaks Out, Targets Higher Highs
Price action on EUR/USD (a 4-hour chart of which is shown) as of Tuesday (10/05/2010) has continued its dramatic recent bullishness by breaking out above prior key resistance in the 1.3800 price region, establishing an 8-month high in the process. This occurs within an exceptionally steep, continuing uptrend channel extending from mid-September. For more technical analysis on this currency pair, please click here for Tuesday’s (10/05/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
USD/CHF - Pullback in Bearish Trend
Price action on USD/CHF (a 4-hour chart of which is shown) as of Monday (10/18/2010) has been making yet another bullish retracement beginning late last week, within the context of the strong bearish trend that has characterized this currency pair since early June. Price action hit a high around 0.9650 in early Monday trading before retreating. For more technical analysis on this currency pair, please click here for Monday’s (10/18/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
EUR/GBP - Bullishness Continues Uptrend
Price action on EUR/GBP (a 4-hour chart of which is shown) as of Tuesday (10/12/2010) has made a swift breakout above key resistance in the 0.8730 price region as well as a counter-trend retracement trendline that has been in place since late last week. This breakout occurs within the context of a clear parallel uptrend channel extending back to the early September low. For more technical analysis on this currency pair, please click here for Tuesday’s (10/12/2010) Chart of the Day.
James Chen, CTA, CMT
* For information on my DVD set, High-Probability Trend Following in the Forex Market, please click here.
* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.
* For information on my new book, Essentials of Technical Analysis for Financial Markets (Wiley), please click here.
Today’s U.S. and Canadian Data
October 14, 2010
The U.S. August trade deficit of $46.2 billion split the difference between the June and July shortfalls of $49.8 billion and $42.6 billion and so seems pretty representative of the present underlying trend. The year-to-date deficit was $100 billion greater than in January-August 2009, a deterioration of $12.5 billion per month. China and OPEC each account for roughly 28% of the increased merchandise trade gap this year compared to last year, while Europe and the Western Hemisphere caused about a fifth of the deficit’s growth apiece. The deficit with Japan was $11.3 billion wider in the first eight months of 2010 than a year earlier. Net foreign demand seems likely to exert a drag on third-quarter GDP growth but not nearly as severe as the 3.5 percentage point negative contribution to overall growth of 1.7% annualized in the second quarter. The rapid post-recession increase of the U.S. trade deficit suggests that the dollar is not yet weak enough to produce a sustainable configuration of global imbalances.
The Canadian trade deficit was nearly halved to CAD 1.345 billion in August from CAD 2.545 billion in July. Exports rose 3.1% on month and by 3.9% if energy is excluded. The bulk of this increase was volume-related. Imports slid 0.5% despite a 2.5% increase in energy imports. Exports of industrial goods and materials rose 5.8%, while imports of such goods fell by 3.3% in the latest month. Despite the smaller trade surplus in August, July-August figures point to a current account deficit in Canada equal to more than 3.5% of GDP in the third quarter.
New U.S. jobless insurance claims increased to 462K last week from an encouraging 449K the week before. Alas, the U.S. labor market is stuck in the mud. New jobless claims in the past four weeks averaged 459K per week, which compares with averages of 467K per week in the twenty weeks to September 11 and 462K per week in the previous twenty-four weeks to April 24, 2010. Do not be fooled into complacency by the lower figure for continuing jobless claims of 4.399 million in the week to October 2nd versus 4.511 million in the previous week. For many people, extended benefits simply ran out, and purse strings will be tightened by the next congress. Analysts are reconciled to the fact that it may take 4-6 years for the labor market to normalize. I have a more bearish take on what normal constitutes. In truth, the normal level of full employment is an ever-rising target, estimated by extrapolating the 1.8% per annum expansion of jobs seen in both the 1980s and 1990s on a vector of same slope from the end of the twentieth century. Using that methodology, the trend line of jobs reaches 175.5 million by end-2015, 192 million by end-2020, and 210 million by end-2025. To hit those levels requires average monthly employment growth of more than 400K, which is doubtful.
U.S. producer prices rose 0.4% on month in September, 4.0% on year and 4.1% annualized over the third quarter. Core producer prices went up 0.1% on month, 1.6% on year, and 2.1% annualized during the third quarter. These results indicate a lack of deflation upstream in the production food chain, and the Fed wants to keep it that way.
Copyright Larry Greenberg 2010. All rights reserved. No secondary distribution without express permission.
Tags: Canada, jobless claims, producer prices, trade statistics, U.S.
ShareThis This entry was posted on Thursday, October 14th, 2010 at 8:49 am and is filed under Deeper Analysis. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site. Tuesday, October 19, 2010
Betting Short Term and Long Term Against the Dollar
Currency market sentiment can change radically in a hurry. Traders were extremely pessimistic about the euro in the spring of 2010, not merely predicting extensive depreciation but also the end of the common European currency as we know it, with both the peripheral members and Germany speculated objects of defection. By early June, the dollar had recovered to 1.1878 per euro, 35% stronger than its record low. Predictions of a 1:1 exchange between the euro and dollar as soon as this year’s fourth quarter were being taken seriously. But with two and a half months left in the year, it is the U.S. dollar, which everyone wants to dump.
Negative dollar momentum is already pretty extreme. In each of the past seven calendar weeks, the U.S. currency has set a lower low than reached in the prior week against the euro, Canadian dollar, Australian dollar and kiwi. The streak of lower lows is up to nine weeks in the case of dollar/Swiss franc. For sterling , the run of lower dollar lows is at five weeks.
Continuing dollar weakness looks about a sure a thing as there is in foreign exchange.
The silence of U.S. officials has convinced market participants that the Obama administration wants a softer dollar. Even if that were an untrue accusation, the 2.5 weeks remaining before congressional elections makes this not a politically correct time for Democrats to impose a floor under the dollar. The U.S. trade and current account deficits are once again rising, and external trade is affecting U.S. GDP adversely. Officials in plenty of other governments are unhappy about the weak dollar but powerless to take effective action against the problem without the cooperation of the United States. Emerging market currencies have been especially well bid. These economies have experienced dramatically stronger economic growth than the U.S. and other advanced economies. The desperate search for a decent return on investment is redirecting a big part of liquidity created by G-7 central banks during the Great Recession to these less developed but more dynamic economies. Efforts by South Korea, Brazil, and China to slow down the appreciation of their currencies has fostered a build-up in dollar reserves. China reported a $194 billion rise of its reserves last quarter to $2.65 trillion. The diversification of that wealth into other reserve currency denominations weakens the dollar against the euro. The Swiss and Japanese experiences with intervention embolden speculators to sell dollars. Intervention provides opportunities to take profits on short dollar positions, and the persistent strength of the franc and yen suggest officials are fighting a dollar battle they cannot win. If one takes relative inflation rates into account, the yen is significantly undervalued relative to the last time it traded in the low 80s against the dollar. Japan, Germany, and Switzerland have large current account surpluses in spite of the rise in the yen, euro and Swiss franc. When the euro was taking shots in the spring, a sliew of risky European banks was a key depressant. The mortgage robo-signer scandal has turned the spotlight back to the plight of the major U.S. money center banks. The Federal Reserve has been about as clear as Fed-speak allows in signaling that a second round of quantitative easing is coming very soon. Only the size is in doubt. The bottom line for U.S. monetary officials is avoiding deflation and promoting job growth to reduce the unemployment rate. The on-year rate of U.S. core consumer price inflation was 0.8% last month, down from 1.5% in the year to September 2009 and 2.5% in the year to September 2008. Core CPI was unchanged on month in both August and September and rose at only a 0.7% annualized rate between June and September. Unemployment has been 9.4% or above since May 2009 and isn’t projected to dip below 9% for many more months. Investors noticed that the Fed conspicuously had virtually nothing to say about collateral damage to other economies that continuing its extremely accommodative policy stance might cause. The problems that other policymakers have are not going to influence Fed policy. As former Treasury Secretary John Connolly famously advised European leaders, “the dollar is our currency but your problem.” The Fed is now more dovish than any other advanced economy central bank. The ECB is pursuing an exit strategy of its unconventional liquidity-enhancing measures. The Bank of England is equivocating on whether it should tighten or ease next. Central banks in Australia, Sweden, Norway, New Zealand and Canada have already lifted their key interest rates. The euro area has reported some encouraging above-consensus economic indicators, such as a 1.0% on-month rise of industrial production in April, Germany’s 40K drop in unemployment last month, and a further 0.9-point rise in Euroland economic sentiment to a 32-month high. The yuan’s sharpening rise has plenty of disbelievers in the marketplace, who doubt the shift will persist once the upcoming G-20 meetings are over. In any case, a rise of 2.5% by China’s currency against the dollar since the Labor Day weekend alleviates only a tiny part of the currency misalignment. The dollar has historically had a bias toward weakness in the final calendar quarter. The non-seasonally adjusted U.S. trade deficit tends to be larger at this time of year than the adjusted deficit. Unadjusted flows are the ones that pass through the marketplace.
With so many negatives in place, investors are unlikely to let today’s rise of the dollar in North America stop a short-term trend that still appears to have plenty of life. When speculation on a directional movement becomes a big force in the market, it often takes coordinated policy efforts to stabilize conditions.
Although the dollar is presently 15.5% and 26.5% below its average euro and yen levels since end-1998, I remain bearish about the long-term fate as well. For more time than I have been a currency market watcher, the dollar has trended downward on balance. There have been numerous multi-year intervals of depreciation and just two such periods of dollar strength. Both of those instances were defined by pretty unique circumstances, which underscore their exceptional nature. The early 1980s saw the Fed engage in quantitative tightening, the United States reassert its military strength, a substantial decline in U.S. inflation, and a large federal deficit that also elevated real long-term interest rates. The late 1990's saw a big improvement in U.S. productivity, strong U.S. real growth with price stability, the unexpected emergence of a large fiscal surplus, and an interlude of peace between the stresses of the cold war and the war on terrorism. Like the early 1980's, it was a time when U.S. officials genuinely seemed to prefer a stronger dollar to a weaker one without any hesitation.
The consistency of dollar softness over four decades has become a reason in itself for being long-term bearish. From DEM 3.992, JPY360 and CHF 4.373 in 1969, it has depreciated by 65% against the mark, 77% against the yen, and 78% against the yen. Oftentimes it is very difficult to discern a near-term trend, but a rule I maintain has stood me in good stead of putting the burden of proof about the dollar’s long-term outlook on why it might strengthen. History shows that the default setting for dollar movement has been downward since the 1960s. At a conference sponsored by Columbia University in February 2009, another person attending asked my opinion on the dollar. A flight to safety had been boosting the U.S. currency at that time, and the recession was at its most intense part. I replied that the dollar’s rebound might be overdone but unsure where the business cycle and therefore the dollar were heading over the next few months. Then, I added that I was much more confident that in the long run the dollar would fall because that was what it does when given enough time. She was naturally unconvinced. A forecast that the dollar will lose value eventually because it usually does is hardly rigorous proof. Yet sure enough, the dollar since that conversation has on balance lost 34% against the Australian dollar, 32% versus the kiwi, 17% against the Swiss franc, 12.5% against the yen, 10% relative to sterling, and 8% against the euro.
The dollar’s weakest levels prior to the euro’s launch in 1999 were touched in the March-April 1995 at DEM 1.3450 and JPY 79.85. Fifteen and a half years later, the synthetic mark and yen are close to those peaks, and one question to ask is whether the United States is sounder now, about as sound, or not as sound at as it was then. Opinion polls point to a significant drop in the nation’s sense of well-being, and that’s why anger is so widespread. The debt machine, which fueled household spending, business investment, and public sector programs, is no longer functional. Unemployment is rampant, retirement savings are insufficient, homes continue to get abandoned, and the government and private sectors are finding promises made in the past to be no longer affordable. Economic expansion is much slower and sporadic, and extraordinarily low interest rates signify fear of deflation. Experts differ on what should be done, and the political process is too disabled to respond if the experts managed to agree on a course of repair. Europe and Japan share many of these problems, but the emergence of a new generation of economic engines has seen the torch of policy coordination passed on to the Group of Twenty from the Group of Seven. To the extent that the dollar embodies the present value of America’s role in the world, common sense implies that the dollar ought to work its way below its lowest levels in 1995.
Negative dollar momentum is already pretty extreme. In each of the past seven calendar weeks, the U.S. currency has set a lower low than reached in the prior week against the euro, Canadian dollar, Australian dollar and kiwi. The streak of lower lows is up to nine weeks in the case of dollar/Swiss franc. For sterling , the run of lower dollar lows is at five weeks.
Continuing dollar weakness looks about a sure a thing as there is in foreign exchange.
The silence of U.S. officials has convinced market participants that the Obama administration wants a softer dollar. Even if that were an untrue accusation, the 2.5 weeks remaining before congressional elections makes this not a politically correct time for Democrats to impose a floor under the dollar. The U.S. trade and current account deficits are once again rising, and external trade is affecting U.S. GDP adversely. Officials in plenty of other governments are unhappy about the weak dollar but powerless to take effective action against the problem without the cooperation of the United States. Emerging market currencies have been especially well bid. These economies have experienced dramatically stronger economic growth than the U.S. and other advanced economies. The desperate search for a decent return on investment is redirecting a big part of liquidity created by G-7 central banks during the Great Recession to these less developed but more dynamic economies. Efforts by South Korea, Brazil, and China to slow down the appreciation of their currencies has fostered a build-up in dollar reserves. China reported a $194 billion rise of its reserves last quarter to $2.65 trillion. The diversification of that wealth into other reserve currency denominations weakens the dollar against the euro. The Swiss and Japanese experiences with intervention embolden speculators to sell dollars. Intervention provides opportunities to take profits on short dollar positions, and the persistent strength of the franc and yen suggest officials are fighting a dollar battle they cannot win. If one takes relative inflation rates into account, the yen is significantly undervalued relative to the last time it traded in the low 80s against the dollar. Japan, Germany, and Switzerland have large current account surpluses in spite of the rise in the yen, euro and Swiss franc. When the euro was taking shots in the spring, a sliew of risky European banks was a key depressant. The mortgage robo-signer scandal has turned the spotlight back to the plight of the major U.S. money center banks. The Federal Reserve has been about as clear as Fed-speak allows in signaling that a second round of quantitative easing is coming very soon. Only the size is in doubt. The bottom line for U.S. monetary officials is avoiding deflation and promoting job growth to reduce the unemployment rate. The on-year rate of U.S. core consumer price inflation was 0.8% last month, down from 1.5% in the year to September 2009 and 2.5% in the year to September 2008. Core CPI was unchanged on month in both August and September and rose at only a 0.7% annualized rate between June and September. Unemployment has been 9.4% or above since May 2009 and isn’t projected to dip below 9% for many more months. Investors noticed that the Fed conspicuously had virtually nothing to say about collateral damage to other economies that continuing its extremely accommodative policy stance might cause. The problems that other policymakers have are not going to influence Fed policy. As former Treasury Secretary John Connolly famously advised European leaders, “the dollar is our currency but your problem.” The Fed is now more dovish than any other advanced economy central bank. The ECB is pursuing an exit strategy of its unconventional liquidity-enhancing measures. The Bank of England is equivocating on whether it should tighten or ease next. Central banks in Australia, Sweden, Norway, New Zealand and Canada have already lifted their key interest rates. The euro area has reported some encouraging above-consensus economic indicators, such as a 1.0% on-month rise of industrial production in April, Germany’s 40K drop in unemployment last month, and a further 0.9-point rise in Euroland economic sentiment to a 32-month high. The yuan’s sharpening rise has plenty of disbelievers in the marketplace, who doubt the shift will persist once the upcoming G-20 meetings are over. In any case, a rise of 2.5% by China’s currency against the dollar since the Labor Day weekend alleviates only a tiny part of the currency misalignment. The dollar has historically had a bias toward weakness in the final calendar quarter. The non-seasonally adjusted U.S. trade deficit tends to be larger at this time of year than the adjusted deficit. Unadjusted flows are the ones that pass through the marketplace.
With so many negatives in place, investors are unlikely to let today’s rise of the dollar in North America stop a short-term trend that still appears to have plenty of life. When speculation on a directional movement becomes a big force in the market, it often takes coordinated policy efforts to stabilize conditions.
Although the dollar is presently 15.5% and 26.5% below its average euro and yen levels since end-1998, I remain bearish about the long-term fate as well. For more time than I have been a currency market watcher, the dollar has trended downward on balance. There have been numerous multi-year intervals of depreciation and just two such periods of dollar strength. Both of those instances were defined by pretty unique circumstances, which underscore their exceptional nature. The early 1980s saw the Fed engage in quantitative tightening, the United States reassert its military strength, a substantial decline in U.S. inflation, and a large federal deficit that also elevated real long-term interest rates. The late 1990's saw a big improvement in U.S. productivity, strong U.S. real growth with price stability, the unexpected emergence of a large fiscal surplus, and an interlude of peace between the stresses of the cold war and the war on terrorism. Like the early 1980's, it was a time when U.S. officials genuinely seemed to prefer a stronger dollar to a weaker one without any hesitation.
The consistency of dollar softness over four decades has become a reason in itself for being long-term bearish. From DEM 3.992, JPY360 and CHF 4.373 in 1969, it has depreciated by 65% against the mark, 77% against the yen, and 78% against the yen. Oftentimes it is very difficult to discern a near-term trend, but a rule I maintain has stood me in good stead of putting the burden of proof about the dollar’s long-term outlook on why it might strengthen. History shows that the default setting for dollar movement has been downward since the 1960s. At a conference sponsored by Columbia University in February 2009, another person attending asked my opinion on the dollar. A flight to safety had been boosting the U.S. currency at that time, and the recession was at its most intense part. I replied that the dollar’s rebound might be overdone but unsure where the business cycle and therefore the dollar were heading over the next few months. Then, I added that I was much more confident that in the long run the dollar would fall because that was what it does when given enough time. She was naturally unconvinced. A forecast that the dollar will lose value eventually because it usually does is hardly rigorous proof. Yet sure enough, the dollar since that conversation has on balance lost 34% against the Australian dollar, 32% versus the kiwi, 17% against the Swiss franc, 12.5% against the yen, 10% relative to sterling, and 8% against the euro.
The dollar’s weakest levels prior to the euro’s launch in 1999 were touched in the March-April 1995 at DEM 1.3450 and JPY 79.85. Fifteen and a half years later, the synthetic mark and yen are close to those peaks, and one question to ask is whether the United States is sounder now, about as sound, or not as sound at as it was then. Opinion polls point to a significant drop in the nation’s sense of well-being, and that’s why anger is so widespread. The debt machine, which fueled household spending, business investment, and public sector programs, is no longer functional. Unemployment is rampant, retirement savings are insufficient, homes continue to get abandoned, and the government and private sectors are finding promises made in the past to be no longer affordable. Economic expansion is much slower and sporadic, and extraordinarily low interest rates signify fear of deflation. Experts differ on what should be done, and the political process is too disabled to respond if the experts managed to agree on a course of repair. Europe and Japan share many of these problems, but the emergence of a new generation of economic engines has seen the torch of policy coordination passed on to the Group of Twenty from the Group of Seven. To the extent that the dollar embodies the present value of America’s role in the world, common sense implies that the dollar ought to work its way below its lowest levels in 1995.
Mexican Monetary Policy Not Changed
The Bank of Mexico, as predicted, made no change in its overnight interbank funding rate, which has been at 4.5% since 375 basis points of reduction implemented during the first seven months of 2009. A statement from officials is fairly dovish in tone, observing that inflation has been under target for two quarters reflecting peso appreciation in part and predicting that inflation is likely to trend down in 2011. The Mexican economy is recovering in an unbalanced way, with high expansion in exports and industrial production offset by lagging upturns in personal consumption and business investment. The next scheduled policy meeting will be held November 26th.
Previews: Swedish Riksbank and Bank of Canada
Monetary policymakers are holding their penultimate interest rate meetings of 2010 this week and will be announcing their decisions on Tuesday. Each of these banks has begun to normalize interest rates, but neither is likely to extend that process at this time. Sweden’s repo rate will hold at 0.75%, and Canada’s overnight money rate should stay at 1.0%.
When the Riksbank repo rate was raised by 25 bps each on July 1 and September 2, not all six policymakers supported the decision. In the latter instance, Svensson objected to the rate hike, and Ekholm favored a flatter future path of rate increases than the majority. The majority’s projected average interest rate of 0.9% in the fourth quarter implies an increase at the final Riksbank meeting in December, not now. Sweden has experienced sounder economic growth than other European nations, leading officials in September to assume that GDP rises by 4.1% this year and 3.5% in 2011. It makes sense for the Riksbank to lead other European central banks in normalizing policy, and the 0.75% rate remains 400 basis points lower than it previous cyclical peak in 2008. However, officials need to take care that they do not proceed so aggressively that the krona appreciates unduly and depresses the economy. Sensitivity to currency wars is even more prevalent now than seven weeks ago, so a desire for gradualism will be highlighted in tomorrow’s Riksbank statement.
The Bank of Canada implemented rate increases of 25 basis points at each of its previous meetings on June 1, July 20, and September 8. The third increase was undertaken despite an admission at the time that “economic recovery in Canada [had been] slightly more gradual than projected in the July Monetary Policy Report.” External circumstances account for this shift. The statement in September mentioned “a weaker profile for U.S. activity,” but Canadian dollar appreciation would now be an additional worry in light of a 5% advance of the loonie since the September meeting. Last Thursday saw Canada’s currency touch 0.9977 per U.S. dollar, a six-month high. Several Canadian statistics meanwhile confirm slower growth. A 0.1% dip of real GDP in July was the first monthly decline in 11 months and followed gains of 0.2% and 0.1% in June and May and no change in April. In July, wholesale turnover and retail sales had each slipped 0.1%, and jobs dropped by 6.6K last month. Building permits fell 9.2% in August, and housing starts declined 1.5% in September. Not every statistic has been softer than forecast, however. The IVEY-PMI index leaped to 70.3 in September from 65.9 in August and also surpassed readings of 61.7 a year earlier and 61.3 in September 2008. That’s a meaningful comparison because this indicator doesn’t get adjusted for seasonal variations. Factory sales and orders rose 2.1% and 5.3% in August, and the trade deficit in August was 47% smaller than the month before, reflecting a 2.9% increase in export volumes.
Canada has benign inflation, so the Bank of Canada can afford to proceed with caution and take a pass at this time. Consumer price inflation was at 1.7% overall and 1.6% for core items in August. Prices in the past three reported months increased 1.4% annualized and by merely 0.8% for the core index. Since the Bank of Canada raised rates in early September, Fed officials have given a much stronger signal of intent to resume quantitative easing at their early November meeting. That shift could drive the Canadian dollar through U.S. dollar parity in a more sustainable way, which would be regrettable. Prudence dictates that Canadian monetary officials take a wait and see stance at this time. A new Canadian rate statement will be posted on the Bank of Canada web site at 13:00 GMT Tuesday. The central bank’s Monetary Policy Report will be published two days later.
When the Riksbank repo rate was raised by 25 bps each on July 1 and September 2, not all six policymakers supported the decision. In the latter instance, Svensson objected to the rate hike, and Ekholm favored a flatter future path of rate increases than the majority. The majority’s projected average interest rate of 0.9% in the fourth quarter implies an increase at the final Riksbank meeting in December, not now. Sweden has experienced sounder economic growth than other European nations, leading officials in September to assume that GDP rises by 4.1% this year and 3.5% in 2011. It makes sense for the Riksbank to lead other European central banks in normalizing policy, and the 0.75% rate remains 400 basis points lower than it previous cyclical peak in 2008. However, officials need to take care that they do not proceed so aggressively that the krona appreciates unduly and depresses the economy. Sensitivity to currency wars is even more prevalent now than seven weeks ago, so a desire for gradualism will be highlighted in tomorrow’s Riksbank statement.
The Bank of Canada implemented rate increases of 25 basis points at each of its previous meetings on June 1, July 20, and September 8. The third increase was undertaken despite an admission at the time that “economic recovery in Canada [had been] slightly more gradual than projected in the July Monetary Policy Report.” External circumstances account for this shift. The statement in September mentioned “a weaker profile for U.S. activity,” but Canadian dollar appreciation would now be an additional worry in light of a 5% advance of the loonie since the September meeting. Last Thursday saw Canada’s currency touch 0.9977 per U.S. dollar, a six-month high. Several Canadian statistics meanwhile confirm slower growth. A 0.1% dip of real GDP in July was the first monthly decline in 11 months and followed gains of 0.2% and 0.1% in June and May and no change in April. In July, wholesale turnover and retail sales had each slipped 0.1%, and jobs dropped by 6.6K last month. Building permits fell 9.2% in August, and housing starts declined 1.5% in September. Not every statistic has been softer than forecast, however. The IVEY-PMI index leaped to 70.3 in September from 65.9 in August and also surpassed readings of 61.7 a year earlier and 61.3 in September 2008. That’s a meaningful comparison because this indicator doesn’t get adjusted for seasonal variations. Factory sales and orders rose 2.1% and 5.3% in August, and the trade deficit in August was 47% smaller than the month before, reflecting a 2.9% increase in export volumes.
Canada has benign inflation, so the Bank of Canada can afford to proceed with caution and take a pass at this time. Consumer price inflation was at 1.7% overall and 1.6% for core items in August. Prices in the past three reported months increased 1.4% annualized and by merely 0.8% for the core index. Since the Bank of Canada raised rates in early September, Fed officials have given a much stronger signal of intent to resume quantitative easing at their early November meeting. That shift could drive the Canadian dollar through U.S. dollar parity in a more sustainable way, which would be regrettable. Prudence dictates that Canadian monetary officials take a wait and see stance at this time. A new Canadian rate statement will be posted on the Bank of Canada web site at 13:00 GMT Tuesday. The central bank’s Monetary Policy Report will be published two days later.
Turkish Central Bank 7.0% One-Week Repo Rate Retained as Forecast
The interest rate structure at the Central Bank of the Republic of Turkey was reached in November 2009 after 1025 basis points of cuts during the preceding year. Officials today decided not to raise the 7.0% 1-week repo rate or any of the other key rates it uses. The decision was as expected and explained in a statement posted on the bank’s web site. Like officials in other emerging markets, monetary authorities in Turkey are concerned about the effects of heavy capital inflows. Although proceeding with an exit strategy on emergency funding — for example, three-month repos are being discontinued — they are unwilling to embark on a more conventional tightening of credit policy. A 7% seven-day repo rate is being maintained despite a rise of CPI inflation from 7.6% in July to 8.3% in August and 9.2% in September. With considerable excess capacity including a 10.5% jobless rate, inflation is expected to settle back, and core inflation is projected to stay consistent with the bank’s medium-term targets.
The sentence devoted to future rate guidance reads, “In light of these assessments, the Committee has reiterated that it would be necessary to maintain policy rates at current levels for some time, and to keep them at low levels for a long period. On the other hand, in order to enhance the efficient functioning of the Turkish lira market, the Committee has decided to reduce the borrowing rates by 50 basis points.” In May of this year, officials made a technically inspired switch of their benchmark interest rate from the overnight borrowing rate of 6.5% at that time to the 7.0% one-week repo rate. A month ago, the borrowing rate was sliced to 6.25%, and the 9.0% overnight lending rate was also cut by 25 basis points to 8.75%, and those adjustments were likewise called “technical.” This month, the borrowing rate has been cut further to 5.75%, 11 percentage points less than its peak level prior to November 2008. Officials also ended three-month liquidity RP tenders as a further step in their “exit strategy.”
The sentence devoted to future rate guidance reads, “In light of these assessments, the Committee has reiterated that it would be necessary to maintain policy rates at current levels for some time, and to keep them at low levels for a long period. On the other hand, in order to enhance the efficient functioning of the Turkish lira market, the Committee has decided to reduce the borrowing rates by 50 basis points.” In May of this year, officials made a technically inspired switch of their benchmark interest rate from the overnight borrowing rate of 6.5% at that time to the 7.0% one-week repo rate. A month ago, the borrowing rate was sliced to 6.25%, and the 9.0% overnight lending rate was also cut by 25 basis points to 8.75%, and those adjustments were likewise called “technical.” This month, the borrowing rate has been cut further to 5.75%, 11 percentage points less than its peak level prior to November 2008. Officials also ended three-month liquidity RP tenders as a further step in their “exit strategy.”
Monday, October 18, 2010
Bank of Korea Fails to Raise Key Interest Rate
For a third straight monthly meeting, the seven-day repo rate was left at 2.25%. This decision was made in the face of an increasing risk factor from the volatility of exchange rates. That factor is getting greater priority than rising CPI inflation, which has advanced to a 12-month pace of 3.6% compared to 2.2% a year earlier and 2.6% earlier this summer. Officials attribute the uptick of inflation to “a sudden rise in farm product prices” and warn of future demand-side upward pressure. Annualized quarter-on-quarter growth slowed in South Korea to 5.8% in 2Q from almost 9% in 1Q, and industrial production is running 17% higher than a year ago. But won appreciation against the dollar despite heavy Korean intervention has Seoul officials in a cautious mood. Only one increase of the repo rate has been implemented so far, an adjustment of 25 basis points in July. The rate had been previously at 2.0% since February 2009. It was cut during Korea’s recession from a peak of 5.25% by 100 bps in August 2008, 175 bps in December 2008 and 50 bps in February 2009.
25-Basis Point Rate Hike in Chile
The Central Bank of Chile met market expectations, raising its benchmark interest rate by 25 basis points to 2.75%. A statement from officials noted that inflation and expected inflation had eased and, related to this as a causal agent, the peso continues to appreciate against the dollar. Growth was brisk in the second quarter at 18.4% annualized and 6.5% in on-year terms, but the other factors enabled the central bank to halve the size of its rate increase. Increases of 50 basis points apiece had been made in June, July, August and September. Over the first seven months of 2009, the benchmark interest rate was slashed from 8.25% to 0.50%.
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