What central bankers want but can't say.......

Wednesday 27th May 2015

 What central bankers want but can't say.......

 "Central bankers pray for a US dollar rebound" , The Financial Times , p.28

First up, some approximate numbers : in July last year the Dollar index, a trade-weighted measure of the dollar's value against a basket of currencies, stood at around 80.0 . A prolonged rally saw it break the 100.0 barrier in March, before sliding back to near the 93.0 level on May 14th. The last two weeks have seen renewed strength and yesterday it traded through the 97.0 level. If you think about it in percentage terms over short time periods, these are significant moves.

You wont find many central bankers openly admitting to a desired target range for their respective currency. For one thing, such an admission can become an unbearable rod for their own back if the market decides upon an entirely different valuation. It may also upset their counterparts in other trading partners with whom they should be acting in a spirit of cooperation at the very least. But as a very general rule of thumb, in difficult economic times, a weaker currency is welcomed due to its beneficial effects on exports. Which is of course why the dollar reversal between March and mid-May was viewed with some concern.

Leaving special considerations aside for a moment, foremost amongst the factors that constantly drive foreign exchange markets is interest rate differentials, and importantly perceptions of FUTURE interest rate differentials. Aggressive monetary easing (near-zero rates, QE etc) implemented widely across the globe at a time when the next move in rates in the US is guaranteed to be on the upside played a large part in the dollar rally. But in many nations the monetary easing card has been played  --  there is little further scope to cut rates. Besides, such action can have uncomfortable side-effects, not least a distinctly unwelcome housing price boom. Central bankers will be hoping that events in the US run their course as expected, and soon.

So what about the US ? After a rotten first quarter that put back expectations of the timing of a rise in rates, better numbers last week and a reminder from Fed Chairwoman Yellen of the intention to raise at some point has reignited speculation about its timing. Are we talking September now ? Some sustained healthy data will be required but maybe so. Whilst the US has its own concerns about the adverse effects of a strong dollar on exports, the rhetoric suggests these will play little part in the Fed's decision making.

And what about those special considerations ? Well for example, the Euro has obviously been undermined by the running sore that is the Greek issue. The overriding view is that "Grexit", should it happen, would seriously damage the credibility of the whole Euro project but some might make the case that Grexit would constitute an excising of the wound (to continue the metaphor) and longer-term could be supportive of the Euro. Mmmm, we shall see on that one but is there a new spectre looming ? A strong showing in Spain's local elections by the anti-austerity Podemos party suggests real problems for the ruling Popular party in November's general elections. Ironically, Spain is the shining example of a country that has taken its medicine and now boasts the strongest growth of all the larger nations, albeit from a low base. Plainly, PM Rajoy needs to convince the voters that he can address the issue of devastating unemployment levels, and he's got very little time in which to do it.