Is the Fed trying to support the dollar?

October 9, 2009 — Mitul Kotecha

Did Fed Chairman Bernanke really provide any real support to the dollar when he said at the Board of Governors conference on Thursday that the Fed will be prepared to tighten monetary policy when the outlook for the economy “has improved sufficiently”. Various newswires report that these comments have given the dollar some relief but the reality is that Bernanke only stated the obvious. Of course the Fed has to raise interest rates at some point and most likely this will be when the economic recovery looks sustainable. There is indication when this point in time will be, however.

In fact there was unsurprisingly no sign from Bernanke that the Fed was preparing to raise rates any time soon. As was noted in the September 23 Fed FOMC statement Bernanke reiterated that the Fed “believe that accommodative policies will likely be warranted for an extended period”. An extended period could mean at the least some months but even years and this is no exaggeration.

In 2001 the Fed did not begin to hike rates until around 2 ½ years after the end of the recession whilst in 1990-91 rates did not go up until close to 3 years after recession ended. Arguably this recession was worse in terms of depth and breadth suggesting that it will take a long time before the Fed even contemplates reversing policy. In any case the first step is to reduce the size of the Fed’s balance sheet.

Admittedly there has been some suggestions from other Fed members that when interest rates are raised it may be done “with greater force” as stated by Fed Governor Warsh recently but others such as NY Fed President Dudley have said that the pace of recovery “is not likely to be robust”, suggesting a more cautious tone and also highlighting that there is some debate within the Fed about the timing of exit strategies and raising interest rates.

There is no doubt that some Fed members are becoming more nervous about holding policy at such an accommodative level but it could still be several months before policy is reversed given the massive excess capacity in the product and labour markets and benign outlook for inflation. Judging by past history markets have little to be nervous about in terms of an early rate hike.

For the dollar this is bad news and as noted in my previous post the dollar will suffer from a growing yield disadvantage as other countries raise interest rates ahead of the Fed. The dollar may have benefited from some short covering at the end of the week and this could have been provoked by Bernanke’s comments but if so, the dollar’s gains are likely to be short-lived as investors take the opportunity of better levels to take short positions in the currency.

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Where will interest rates go up next?

October 7, 2009 — Mitul Kotecha

Following the decision by the Reserve Bank of Australia to raise interest rates attention has swiftly turned to which central bank will move next. Indeed, there has been a reassessment of global interest rate decisions following Australia’s move. The hike in Australia is unlikely, however, to be quickly followed by the US, Japan, Europe or UK where policy is set to remain highly accommodative for long while.

Attention will however, turn to the Bank of Korea as well as the RBNZ and Norges Bank. In particular, the Norges Bank may be the next to hike when it meets on October 28. Norway has already appears to be priming markets for a rate hike. The RBNZ is likely to be slower to hike given the still slow pace of recovery in New Zealand and comfortable inflation backdrop.

The impact on currencies is not straightforward as the bigger influence on currency markets throughout the crisis has been risk appetite rather than interest rates. However, the influence of risk on currencies is beginning to wane and although interest rates have not been a major driver of currencies over recent months the move by the RBA likely accelerates the process of yield re-emerging as a key currency driver.

This is a big problem for the US dollar given that the Fed is unlikely to be quick to raise interest rates even if quantitative easing is withdrawn sooner. This means that the dollar will suffer from a growing yield disadvantage as interest rate hikes are priced in elsewhere. Taken together with improving risk appetite as reflected in the resilience of global equity markets, the main casualty will be the dollar, hit both from a yield and risk appetite perspective.

Risk currencies and those currencies with the greater prospect of higher rates will do well meaning further upside for the Australian dollar and New Zealand dollar as well as the Norwegian krone. Asian currencies look to continue to strengthen with the Korean won remaining an outperformer despite intervention threats by the Korean central bank. The euro will benefit from dollar weakness but is unlikely to benefit from anything euro specific given the likely slower pace of recovery in the eurozone. Meanwhile sterling is likely to remain under pressure, not helped by yield or risk appetite, and sentiment hit afresh by weak data.

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Talking about currencies

October 5, 2009 — Mitul Kotecha

It’s always the same story.  Ahead of the G7 (or G8 and now more important G20) meetings speculation of decisive action on currencies intensifies.  Traders and investors become cautious on the off chance that something significant will happen but the majority of times nothing of note emerges.

There was no difference this time around.  The G7 Finance Ministers meeting in Istanbul failed to deliver anything substantive on currencies, repeating the usual mantra about the adverse impact of “excess volatility and disorderly movements”.  Although the group pledged to monitor FX markets there was no indication of imminent action. 

The lack of action is perhaps surprising in one respect as there were plenty of central bankers and finance officials talking about currencies in the run up to the G7 meeting, most of which were attempting to talk the dollar higher against their respective currencies.  Given the increase in rhetoric ahead of the meeting, the relatively weak statement now leaves the door open to further dollar weakness.

The strongest indication of any FX action or intervention came from the country that was supposedly the least concerned about currency strength; Japanese Finance Minister Fujii warned that Japan “will take action” if “currencies show some excessive moves”.  The shift in stance from Japan since the new government took power has been stark (considering that the new government was supposedly in favour of a stronger yen).  Markets will likely continue to test the resolve of the Japanese authorities and buy yen anyway.

Although the G7 statement said little to support the dollar and the overall tone to the dollar likely remains negative over coming months, the softer tone to equity markets and run of weaker economic data in the US – the latest data to disappoint was the September US jobs report – may give some risk aversion related relief to the dollar this week. 

Weaker data and equities alongside the impact of official rhetoric is being reflected in CFTC Commitment of Traders’ data (a good gauge of speculative market positioning) which revealed a sharp drop in short dollar positions, by around a quarter, highlighting for a change, an improvement in dollar sentiment over the last week. 

The biggest losers in terms of speculative positioning were the British pound, where the net short position reached its most extreme since mid September 2008, and Canadian dollar where the net long position was cut by almost half.  Again this may reflect official views on currencies, with Canadian officials expressing concern about the strength of the Canadian dollar in contrast to the perception that UK officials favour a weaker pound.
Central bank meetings (BoE, ECB, RBA) will dominate the calendar this week and more comments on currencies are likely even if interest rates are left unchanged.  Meanwhile FX markets will continue to watch equities, and the start of the US Q3 earnings season will give important signals to determine the sustainability of the recent equity market rally.  Recent weak economic data has already cast doubt about a speedy recovery and if earnings disappoint risk aversion could once again be back on the table.

Posted in central banks, Currencies, Economics, Economy, equity markets, Europe, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Economic reality check supports dollar

October 2, 2009 — Mitul Kotecha

The US dollar appears to be making a tentative recovery of sorts at least when taking a look at the performance of the US dollar index.  Much of this can be attributable to a softer tone to equities. The S&P 500 registered its biggest back to back quarterly rally since 1975 over Q3 and either through profit taking or renewed economic doubts, stocks may be in for shakier ground into Q4. 

This increase in equity pressure/risk aversion is being triggered by weaker data. Since the Fed FOMC on 24th September the run of US data has generally disappointed expectations; in addition to the ISM survey, existing and new home sales, durable goods orders, consumer confidence and ADP jobs data all failed to match forecasts.   This list was joined by the September jobs data which revealed a bigger than expected 263k drop in payrolls.  Consequently doubts about the pace of recovery have intensified as markets face up to a reality check.

The dollar’s firmer tone is not just being helped by weaker stocks but also by plenty of official speakers discussing currency moves. Although this is potentially a dangerous game considering the recent turnaround in Japanese official comments on the Japanese yen the net effect is to support the dollar.  In particular, Treasury Secretary Geithner stressed the importance of a strong dollar, whilst European officials including Trichet, Almunia and Junker appear to have become more concerned with the strength of the euro. 

In the current environment such comments will contribute to putting further pressure on the euro which in any case has lagged the strengthening in other currencies against the dollar over recent months.   Although ECB President Trichet highlighted “excess volatility” in his comments about currencies overnight implied FX volatility is actually relatively low having dropped significantly over recent months.  The real reason for European official FX concerns is quite simply the fact that the eurozone remains highly export dependent and that recovery will be slower the stronger the euro becomes.  

It’s not just G10 officials that are becoming concerned about currency strength against the dollar as Asian central banks have not only been jawboning but also intervening to prevent their currencies from strengthening against the dollar.   A firmer dollar tone is likely to put Asian currencies on the back foot helping to alleviate some of the upward pressure over the short term but the overall direction for Asian FX is still upwards.

Posted in Asia, central banks, Currencies, Economics, Economy, equity markets, Europe, Japan, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Asian currencies on the up

September 30, 2009 — Mitul Kotecha

The third quarter of 2009 has proven to be another negative one for the US dollar.  Over the period the dollar index fell by over 4%.  The only major currency to lose ground against the dollar over this period was the British pound.  Most other currencies, especially the so called “risk currencies” which had come under huge pressure at the height of the financial crisis, registered strong gains led by the New Zealand dollar, Swedish krona and Australian dollar.  Although the euro also strengthened against the dollar it lagged gains in other currencies over the quarter.

Asian currencies also registered gains against the dollar in Q3 but to a lesser extent than G10 currencies.  Asian currency appreciation was led by the Korean won, Indonesian rupiah and Singapore dollar, respectively.  The under performer over Q3 was the Indian rupee which actually depreciated against the US dollar slightly.  The reason for the smaller pace of appreciation for most Asian currencies was due mainly to intervention by Asian central banks to prevent their respective currencies from strengthening too rapidly, rather than due to any inherent weakness in sentiment.

In fact, Asian currencies would likely be much stronger if it wasn’t for such FX interventions.  A good indication of the upward pressure on Asian currencies can be found from looking at the strength of capital inflows into local stock markets over recent months.  South Korea has registered the most equity capital inflows so far this year, with close to $20 billion of flows into Korean equities year to date but in general most Asian stock markets have registered far stronger inflows compared with last year.   

For the most part, balance of payments positions are also strong.  For example, South Korea recorded a current account surplus of $28.15 billion so far this year, compared to a deficit of $12.58bn over the same period last year.  This is echoed across the region.  Although surpluses are expected to narrow over coming months due mainly to a deterioration in the terms of trade, the overall health of external positions across the region will remain strong and supportive of further currency appreciation.  

The outlook for the final quarter of 2009 is therefore likely to be positive for Asian currencies, with the US dollar set to weaken further against most currencies.  Some risk will come from a potential reversal in global equity market sentiment but overall, further improvements in risk appetite will support capital inflows into the region.  Capital will be attracted by the fact that growth in Asia will continue to out perform the rest of the world and yet again only interventions by central banks will prevent a more rapid appreciation of Asian currencies.

Posted in Asia, central banks, China, Currencies, Economics, Economy, equity markets, Financial crisis, India, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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