ALTHOUGH US Secretary Snow sought to downplay the impression of benign neglect towards the US dollar last week, he still fingered Asia as the chief culprit in fixing exchange rates, and thereby maintained the impression that dollar depreciation against those currencies would not be unwelcome.
However, with Asian central banks no longer playing ball by continuing their intervention tactics, the pendulum is swinging back towards commodity currencies, sterling and the euro as the line of least resistance through which to express dollar bearishness. All the more so as these central banks appear to be relatively sanguine about the effects of currency appreciation on their economic recoveries, and many are also contemplating raising interest rates as well.
The latest minutes from the Bank of England’s October Monetary Policy Committee (MPC) meeting showed the bank willing to absorb the positive effects on an already strengthening pound of a tightening in monetary policy. The sterling ERI has been comfortably above the level expected by the MPC in August, and as expectations of interest rate rises begin to harden, a further appreciation can be anticipated, potentially damaging the UK’s net trade position.
The Reserve Bank of New Zealand also released a relatively hawkish monetary policy review this week, while the Bank of Canada expressed a view that a strong Canadian dollar will not be overly harmful to growth.
Although the European Central Bank (ECB) is not yet contemplating tightening, its comments have been among the most relaxed about the impact of euro strength on the eurozone recovery. The ECB’s Vanhala was the latest person to express confidence that the euro’s rise is no risk to the economic recovery, despite the downgraded growth forecasts from the German Government this week. Other ECB officials maintain the view that its current strength is in line with long-term averages.
Equity markets, however, do not appear to believe the argument that strengthening currencies and rising interest rates pose no threat to growth, giving the hawkish language a resounding thumbs down. This threatens to reinforce the currency trends that are underway, whereby equity currencies such as the Japanese yen and the US dollar are getting punished while the ‘carry’ currencies with attractive interest rates are being rewarded.
At least the Fed appears to recognize the potential problem, and according to the Washington Post, will not embark on any tightening itself until there is “unmistakable evidence that significant, sustainable job growth is occurring”. This approach will only underline the US dollar’s (USD) disadvantage at a time when yield appears to be back in vogue.
If Asian countries do not want their currencies to strengthen, and Europe doesn’t seem to mind, it seems we are in the process of returning to the situation for the USD that characterised the first half of 2003. To this end, the cyclical aspects of the US recovery may slow the dollar’s slide, but the structural drivers of the current account almost guarantee further falls in coming months.
Therefore, Asian resistance to currency appreciation will continue to be central to the way the USD’s depreciation evolves from here. While it is unlikely the Bank of Japan will draw a ‘line in the sand’ in the way they appeared to at 115 yen, their approach will still be to slow the pace of the yen’s ascent, a job made momentarily easier by renewed doubts over Japan’s recovery and the latest 5% drop in Japanese stocks.
The US and Asia will continue to wrestle for competitive advantage in 2004, but it may be the eurozone that will be the biggest loser with the strongest currency.
– Tim Fox is head of market strategy, Northern Bank/National Australia Bank, London.
