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Friday September 26, 2008 - 18:48:43 GMT
Larry Greenberg -

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Foreign Exchange Insights

The wires, newspaper, and video press has been loaded with dire predictions for the dollar, even as uncertainty remains high regarding the details of a massive and comprehensive U.S. government rescue plan for bad financial assets.  Confidence remains weak that Secretary Paulson’s plan will be effective  and strong that  disaster will ensue if no action is forthcoming.  Under all conceivable scenarios, conventional wisdom sees problems for the dollar.

The dollar performed better this past week in the market than in the press.  Net weekly changes as of noon today in New York included gains of 0.9% against the Australian dollar and  0.6% against the kiwi, plus insignificant losses of 0.3% against sterling and 0.7% against the euro.  Bigger losses of 1.3% were recorded against the Swiss franc and Canadian dollar and of 1.1% against the yen, but the Swissy and the euro were each 1.9% weaker at noon than their weekly highs.  All other major currencies were significantly below their weekly highs, except the Canadian dollar which was still within 0.4% of its peak.  In a week that saw a virtual complete breakdown in short-term money markets and declines of 5.6% in the Nasdaq, 4.8% in oil prices, and 3.9% in the DJIA as of noon, high-low dollar ranges were considerably narrower this week than for the prior week to September 19th, with the exception of EUR/USD and USD/SWISS.

One is left to conclude a) that the dollar could have had a much tougher week, b) that the dollar will drop sharply in due time, or c) that the experts are missing a key point.  In deciding between the choices, keep in mind that the dollar has weakened lately.  The greenback had previously been experiencing an impressive upward correction, but compared to September highs, it has coughed back 4.8% against the euro, 4.5% against the Swiss franc, 5.8% against the Australian dollar, and 2.7% against the Japanese yen.  Nobody imagined the dollar would make its entire adjustment in September, and it is following the southerly direction that has been projected.  Temporary distortions also muddy the waters.  Quarter-end capital flows will be one such factor for part of next week, too.  Separately, asset liquidations have already dominated trading for much of this month and should continue to be a powerful force.  Capital losses force U.S. investors to repatriate wealth parked abroad, and that activity supports the dollar sporadically.

There is more.  In spite of the U.S. economy’s serious problems, U.S. GDP in a huge surprise expanded much more quickly in 1H08 than did activity in other G7 economies, as my previous posting documents.  U.S. growth slowed sharply in the quarter now ending and is likely to turn negative over the coming two quarters, if not longer.  Even so, Japan and Europe may do no better.  A scenario in which U.S. interest rates are rising while rates elsewhere are falling could emerge during the course of 2009.  While not a guarantee, that possibility remains on investors minds as they think ahead. 

For those who like to compare how different economies are performing, the last week of a month and quarter naturally offers up a wealth of information.  The shape of the government’s deal and the cue from reactions in money markets, bonds, and stocks to the package will be more important than economic indicators to how the dollar performs.  But for data junkies, here’s the rundown of what’s coming out.  The United States releases manufacturing and service-sector PMI’s, auto sales, personal income and expenditures, construction spending, consumer confidence, factory orders and, last and most, the September labor force survey.  Japan gets figures on retail sales and household spending, housing starts, industrial output, household spending, unemployment, the Shoko Chukin monthly survey of small firm sentiment and, most importantly, the Bank of Japan quarterly survey of businesses, also known as the Tankan.  Euroland releases PMI’s for the retail sector, manufacturing, and services.  Indicators also arrive for retail sales, consumer and business confidence, labor market conditions, consumer prices, and producer prices.  The last estimate of British quarterly growth is due, along with the U.K. current account.  In addition, there will be housing market data, banking numbers, and consumer confidence from the British economy.  Canada reports August GDP, and Australia releases retail sales, credit growth, and trade figures.

Although the only major central bank meeting on the calendar is at the ECB, the Fed’s benchmark interest rates are the ones most likely to be cut.  My thinking there is explained in a posting from yesterday.  Comments by ECB officials including some today have revealed no hint of an imminent rate cut, and so I do not expect that bank to ease after Thursday’s meeting even if the Fed has reduced U.S. rates.  But there is a caveat.  The world financial community is staring down an abyss that only people of age 80 or older can remember, and the feedback loops to all other economic sectors are locked and loaded.  Times are ripe for a major coordinated policy surprise like the Plaza Summit Accord 23 years ago this month.  We will not see just the ECB and Fed cut rates.  It is likelier to see as many as seven central banks cut rates, but I still consider such pretty remote.

The meeting of G7 finance ministers and central bankers in Washington next month, which will be their third scheduled gathering of 2008, should carry greater than usual importance of currency market participants.  When this group met last April 11th, language protesting currency market developments, namely the ever-softening dollar, was escalated:

“We reaffirm our shared interest in a strong and stable international financial system.  Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability.”

Much has happened since those words were inked, including a recovery of the dollar and the spike of oil prices from $110.14/barrel on April 10th to a peak of $147.27 in mid-July and subsequent rapid reversal of that climb.  Turmoil in the global financial markets took a very nasty turn this month, which officials did not anticipate in their wildest dreams.  It has forced governments to think outside the box, and that means that policies once sealed in cement may have to be rethought. 

If the chosen way out of the present mess implies dollar debasement, governments are going to have greater tolerance for deprecation.  They are not going to say the dollar ought to be weaker, which was the message of the Plaza Accord.  In today’s environment, such an open admission might fan panic.  Besides, the dollar was very overvalued in 1985 by most measures and now is significantly undervalued, which is why U.S. GDP growth stayed positive in 1H08.  G7 officials have been conspicuously silent about the dollar lately, not even complaining about Beijing’s apparent decision to halt appreciation in the yuan.  Markets will learn much from watching exactly how officials finesse the handling of currency policy leading up to their meeting, in the joint statement that is released, and following that meeting.  I suspect they will say as little as possible and instead concentrate on steps taken to combat the financial market problem.  Such silence may look innocuous at first, but don’t be surprised if it serves as a catalyst for a softening U.S. currency.


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