Hello again. I apologize for the radio silence. I’ve had a couple of knee surgeries over the past several months that turned out to be more extensive than anticipated. During that time, there have been some interesting developments in US and global capital markets that I didn’t get a chance to opine on. The first was the Fiscal Cliff impasse at the end of the 2012 (I did comment some on that one), which was a simultaneous increase in tax rates and decrease of government spending through sequestration that would have occurred January 2013. In eleventh-hour negotiations on Capitol Hill, the legislature devised and then passed the American Taxpayer Relief Act of 2012 on January 2nd. The Act gave permanence to the lower rate of much of the Bush tax cuts, while retaining the higher tax rate at upper income levels that became effective on January 1 as a result of the expiration of the Bush tax cuts. However, it didn’t address spending cuts (the sequestration). Enactment of those got pushed out to March 1st. While there was much saber rattling and doomsday speak in the lead up to March 1st about the blunt nature of the cuts, Washington failed to reach any agreement on cuts and they went into effect. US equity markets yawned at the news for the most part as the Dow has been on fire now sitting at or near historical highs. Many economists and the IMF project that the decrease in government spending will decrease GBP roughly half a percentage point. The jury is still out on that, but the positive US data as of late has caused the greenback to rally.
In global FX markets, the topic of currency wars (or the race for the bottom as it was being know) was receiving quite a bit of press over the past several months. China used to be the main name that would come up in any discussion about currency manipulation, but they haven’t gotten much attention lately as the central banks of countries like Japan and Switzerland have actively and publicly stepped into their currency market to cause their respective currencies to stabilize (Switzerland put in a floor against the Euro at 1.20) or depreciate rapidly as the case of Japan. In actuality, it seems just about every country has enacted policy of some sort some to cause their currency rates to depreciate to make their exports more competitive on the global market. In the US, the dovish policy by the FOMC certainly has contributed to weakness of the greenback in the past. However, according to data from the Bank of International Settlements, the most aggressive currency warriors in the past 5 ½ years have been South Korea and the UK, but you don’t hear much about them in any discussion.
Anyway, that brings us to events of today. One of the most notable things to happen in FX markets this week appears to be reversal of the USD correlation to positive US data. In the past, strong US data has typically led to a weakening of the USD as investors, emboldened by positive risk appetite, would seek higher returns in currencies outside the US when there was good news from the world’s largest economy. However, more recently, strong US data has led to USD strength. It appears the relation between US data and policy expectations has changed. In the past, with the FOMC at the dovish end of central banks, strong US data had little implications for changes in Fed policy, and consequently for the USD, but has supported risky assets. However, with the Fed tying their policy to an unemployment threshold, the decrease in unemployment has been a key factor supporting the dollar. And as we saw, there was more positive employment data out in the US as the headline rate decreased to 7.7% last Friday. We’ve seen the greenback strengthen against most currencies lately on this development, particularly the Pound (now around 1.49) and the Yen (96.03).
I also received the monthly consensus currency forecast late last week:
Look for more headlines out this week from the Eurozone at the EU Summit on the 14th and 15th. As in past EU summits, it’s doubtful that any of those headlines will really move markets.
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