The yen is taking a bit of a breather today after hitting a six-month low against the U.S. dollar yesterday. Today’s slight rise in the yen—0.57%–takes the yen to 102.37 to the dollar. Japan’s currency is down 14% for 2013 against the U.S. dollar.
And since Tokyo stocks climb as the yen falls—on expectations that a cheap yen will create more sales overseas for Japanese companies and add to revenue and earnings as strong currencies are converted into yen for hometown balance sheets—Japanese stocks moved up to just short of a six year high for the Nikkei 225 Stock Index at a December 3 close of 15,749.70. That’s the highest level for the index since December 12, 2007.
The pause for the yen—and most likely for Japanese stocks too—comes as investors and traders wait to see what the European Central Bank will do on rates at its Thursday, December 5 meeting. The central bank is most likely to stand pat rather than cut interest rates at the meeting.
Investors and traders are also waiting on U.S. jobs data due on Friday, December 6. In October the U.S. economy added 204,000 jobs and a number significantly above that report would add to fears that the Federal Reserve will move to begin tapering off its $85 billion a month in asset purchases with its December 18 meeting. Economists surveyed by Bloomberg are projecting that the U.S. economy added 181,000 jobs in November.
Right now it looks like investors and traders in Japan—and in Europe and the United States—are in a wait and see/protect the profits mode in front of the Thursday and Friday news.
Remember when developing economy currencies and emerging market stocks fell as bets that the Federal Reserve would begin to taper off its $85 billion in purchases of Treasuries and mortgage-backed assets sooner rather than later caused the U.S. dollar to climb?
In August when everyone was convinced that the Fed would begin The Taper at its September meeting, emerging market currencies and assets slumped. For example, on August 21 the iShares MSCI Brazil ETF (EWZ) hit a low of $41.26, finishing off a 24.9% slide that had begun on May 20.
We’ll we’re seeing a replay now. Emerging market shares have tumbled for nine days in a row, the longest slide since 2006. The iShares MSCI Emerging Markets Index ETF (EEM) has declined to its lowest level in two months.
Developing economy currencies have moved lower too. The Indian rupee has fallen to an eight-week low. On November 12 the South African Rand hit its lowest level in two-and-a-half months.
The driver for this decline is a belief that the odds have improved that the Fed might begin The Taper at the December 18 meeting of the Federal Open Market Committee. The majority opinion among economists, according to a Bloomberg survey, still points to an initial move at the committee’s March 19 meeting, but the odds on a December or January taper have improved recently. At the end of October, Citigroup, for example, raised the odds on a December taper to 20% from 10% and on a January taper to 45% from 25%. I don’t think the rest of Wall Street has moved that strongly toward a December or January taper, but the Citigroup change gives you a good idea of the trend.
It’s not so much that the consensus has changed radically as that traders see more of a need to hedge positions in case the consensus is wrong.
The Federal Reserve’s decision not to begin tapering off its monthly $85 billion in purchases of Treasuries and mortgage-backed securities sent the dollar even lower against most global currencies. Today, September 19, the Dollar Index fell to a seven-month low. The dollar fell against the currencies of most U.S. trading partners—except Japan. And it looks like the dollar will stay under pressure for at least the next few sessions.
The big question is how long this trend lasts. If you think it will run for a while, then you want to join in on the rally in emerging market stocks that has accompanied the rally in emerging market currencies such as the rupee and real. If you think the run is getting a little over-extended—the euro is, after all at levels against the dollar that have marked resistance in the past BUT and it has recently broken above resistance at $1.345 to close today above $1.35—then this is a time to take some profits.
A lot will depend, in my opinion, on how big a scare Washington politics throws into global financial markets. I can’t imagine overseas investors rushing to move into dollars in the face of rhetoric threatening a government shutdown and a default on U.S. debt. I’d say current trends could hold for a couple of weeks yet, but I wouldn’t be rushing to add new positions that depend on dollar weakness right here
The one currency that is running against the weak dollar tide is the Japanese yen. The yen initially climbed on the Fed’s no taper decision—rising to 97.75 on the news—but then fell all the way back to 99 yen to the dollar and finished today at 99.42. (Remember that since the yen is quoted in yen to the dollar, a higher number is a sign of a weak yen and a smaller number means the yen is getting stronger.) The thinking seems to be that the recent Japanese trade deficit will push the Bank of Japan to further weaken the yen in order to boost Japanese exports. I continue to think that the yen will finish 2013 at weaker levels than current trading and that leads me to continue to hold positions in Japanese stocks such as Toyota Motor (TM) and Mitsubishi UFJ Financial Group (MTU). Both stocks are members of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did own shares of both Mitsubishi UFJ Financial and Toyota Motor as of the end of June. For a complete list of the fund’s holdings as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
Do you know the facts of life of the global currency market right now?
Is the U.S. dollar headed up or down over the next few weeks? How about the Japanese yen? Is the Indian rupee and the Turkish lira and the South African rand headed into a crisis? How about the Brazilian real?
I’m asking because right now global cash flows—into some developed markets and out of most emerging markets—are driving the prices of global stocks and bonds. The effects of those cash flows are being expressed in the prices of currencies such as the dollar and the real. The movements of those currencies are both the expression of those cash flows—the way that they’re being turned into rallies and corrections in the financial markets—and, increasingly, the fundamental driver for price movements in those markets as the ups and downs of currencies cause changes in monetary policies in countries such as Brazil and India. And finally, if you’re trying to figure out where the bottom is for Asia’s emerging markets—which entered official bear market territory this past week when the iShares MSCI South East Asia Index fell to a 21% drop from the peak on May 8—I think understanding the likely currency moves over the next quarter or two is a key. (That index tracks the markets in Singapore, Thailand, Malaysia, the Philippines, and Indonesia.
So here’s my take on what you need to know about global currencies in 10 easy trends.
- In the short run the U.S. dollar is likely to get stronger against most global currencies. That’s because the gradual end of the Federal Reserve’s program to purchase $85 billion a month in Treasuries and mortgage-backed assets—possibly as early as the Federal Open Market Committee’s September 18 meeting–will push U.S interest rates at least slightly higher. With the rest of the developed world’s central banks still in stimulus mode (Japan) or in do-nothing mode (Europe), that means traders and investors looking for higher yields will turn to buying dollar denominated assets.
- We really don’t know how long the “short run” might be. It’s clear that Japan isn’t about to reverse its weak yen policy any time soon and the European Central Bank has revised its historic tendency to privilege low inflation above economic growth to the extent of keeping interest rates at historic lows for a long period of time as the EuroZone struggles to escape recession or near recession. But a sufficiently chaotic U.S. political season—one that saw a budget impasse and a credible threat of default resulting from a failure to raise the debt ceiling–could make the dollar seem decidedly less attractive as early as October.
- A strong dollar is a negative for commodities priced in dollars—such as oil—and for precious metals. Extreme fear and turmoil, such as that set off by the threat of U.S.-led military intervention in Syria can overwhelm the effects of a strong dollar in the short run. Gold was up 19% from its June low as of August 29 to $1409.80, but I think gold along with other physical commodities will have a hard time building a sustained rally as long as the U.S. dollar keeps moving up and as long as global growth remains slow enough to remove all fears of inflation. The pressure that a strong dollar puts on commodity prices plus weak commodity prices due to slow demand from China and other developing economies has hit commodity currencies hard. For example, the Australia dollar traded near 89 cents on August 28. That’s down from $1.05 in April.
- A strong dollar isn’t good for emerging market financial assets. In 2012 as the U.S. Federal Reserve expanded its balance sheet, $1.2 billion flowed into emerging financial markets. In 2013 that cash flow has reversed.
- The countries, currencies and financial markets hardest hit by the strong dollar are those running the biggest current accounts deficits. Economies such as India, Indonesia, and Turkey need to attract overseas cash in order to balance those deficits. Turkey, for example, needs to attract $5 billion a month.
- A falling currency can set off a vicious cycle in a current account deficit country. A falling currency makes it harder to attract the cash needed to balance a current account deficit. And worries over a country’s inability to cover its deficit can lead to a further retreat in the currency as investors and traders pull money out of assets that are worth less in dollar terms day by day.
- A stronger dollar and weaker local currencies works to make trade deficits higher in developing economies. For example, India imports about 80% of its fuel. A climb in the dollar price of benchmark Brent crude makes it more expensive to pay India’s fuel bill in rupee. India’s oil imports averaged $14.2 billion a month in the first seven months of 2013, up from $13.9 billion a month in the same period a year earlier. The same dynamic savages companies in emerging economies that collect revenues in local currencies but that have to pay costs in dollars. About 56% of the costs at Brazil’s airlines, for example, are denominated in dollars, mostly for jet fuel. If, as in the case of India, a relatively weak manufacturing sector makes it hard to take advantage of a cheaper currency to increase exports, a falling currency is a lose/lose proposition
- The potential responses by central banks to falling currencies all have nasty side effects. Central banks can intervene by spending down foreign exchange reserves to buy local currencies. That can actually weaken a local currency if the markets believe that the central bank doesn’t have the foreign exchange reserves or the policy will to spend enough to reverse the market trend. That’s the market’s take to date on interventions by India, Indonesia, and Turkey. Another potential response is to defend a currency by raising domestic benchmark interest rates. That has a potential toxic side effect: Higher interest rates slow rates of economic growth. That seems to be happening now in Brazil
- All this has made emerging market stocks and bonds cheaper, but also has led investors and traders to question if these markets are cheap enough yet. For example, the Indian rupee is down 20.1% n 2013 on its way to its worst loss since the 1991 balance of payments crisis forced the government to sell gold to pay for imports. But even at 68.845 rupees to the U.S. dollar on August 28, that may not be a bottom. Speculation now is that the currency will have to sink to at least 70 rupees to the dollar before this crisis is over. No one, right now though, is willing to bet very heavily that 70 rupees to the dollar will make a bottom
- Putting in a bottom in emerging markets in general will probably start with putting in a bottom in individual economies with larger foreign exchange reserves and that look closer to seeing economic growth move from slowing to expanding. Brazil is a strong candidate for an early turn on sufficient foreign exchange reserves, and a central bank that has been early to raise interest rates. But growth in Brazil is still anemic. Mexico is another early recovery candidate, especially if the government’s efforts to increase foreign investment in the country’s oil industry look like they will result in a significant increase in production at Pemex, the national oil company. An overall recovery in emerging markets, however, is probably a 2014 event and will depend on data showing a believable recovery in China’s rate of economic growth. Or at least confidence that growth in China isn’t about to fall much further. From that perspective improved manufacturing data in the August Purchasing Managers Index for China is a very positive step.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of any stock mentioned in this post as of the end of June. For a complete list of the fund’s holdings as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
At this past weekend’s Jackson Hole central bank gabfest, it looked like global central bankers were aiming for “a Draghi” in order to defuse the current emerging market currency crisis at a cost of nothing more expensive than words.
A harsh response from the U.S. Federal Reserve, however, killed that hope, leaving national central banks with the hard and expensive work of defending their currencies by spending foreign exchange reserves and raising interest rates.
Last summer European Central Bank president Marie Draghi promised to do “whatever it takes” to defend the euro. So convincing did bond markets find that promise that Draghi and the European Central Bank never had to actually do anything. Interest rates in Italy and Spain fell just on his words.
This past weekend began with Bank of Japan Governor Haruhiko Kuroda asserting that his bank’s asset buying would help sustain global growth even as the Federal Reserve considers tapering off its purchases of Treasuries and mortgage-backed securities. Bank of England Deputy Governor Charlie Bean seemed on the same page when he said that his bank’s pledge to keep rates on hold until unemployment reaches 7% should also boost market confidence. Mexico’s Agustin Carstens called on the Fed to spell out their intentions better in the interest of safeguarding global growth.
For a moment, it looked like the conference could produce one of those confidence-building promises to support emerging and global markets
And then the Fed pushed back. Read more