It is important in financial markets to pay attention to those with the money, rather than those with the microphone - as practised by Macro Man - but occasionally politics do impact prices and, when they do, the reaction tends to be one of surprise.
Witness the US dollar. Up until the weekend there was a view - albeit a fragile one - that the American currency might be coming out of its recent squall. After all, debt and equity markets had a fresh air of stability, with commentators even talking of deep value amongst battered banks and the like.
But then the G7 got on the case and started talking about their “shared interest in a strong and stable international financial system,” whereupon the dollar fell out of step with the ‘recovering markets’ story. Message from the politicos: the G7 stands ready to deal with disorderly FX markets. Message from the markets: we’d better try and find something disorderly.
Macro Man notes that compared with other G7 communiques issued at times of crisis in the currency markets, the weekend’s statement was rather limp. It was also from the wrong people:
It’s far from clear that the G7 are the relevant authorities; after all, it’s not Japan or Germany or the UK that is buying billions of EUR/USD every month; it’s China and Russia and the Middle Eastern Countries. And Macro Man didn’t see their names attached to any document expressing concern.
Nouriel Roubini picks up the theme:
Verbal intervention — of the sort used even by Trichet in the last few weeks and used by the G7 in their weekend statement — almost never works (as the Japanese learned a few years ago). Also sterilized fx intervention usually does not work — unless such intervention goes with the wind rather than against the wind, is seriously coordinated and aggressive and signals future changes in actual monetary policies (i.e. unsterilized intervention). What works in affecting exchange rates is unsterilized intervention — or equivalently — changes in relative monetary policies, i.e. changes in policy rates.
Currency movements are driven — apart from market noise and momentum — by economic fundamentals. Several fundamentals are driving the dollar south relative to euro and other floating currencies.
There is of course the little matter of the real underlying health of the American economy , as noted by Kathy Lien:
It is difficult to believe that the economy is improving as indicated by the headline retail sales figure when the nation’s fourth largest bank Wachovia posted a $393 million loss and cut its dividend. More banks will be reporting earnings this week and it will be important to see if the losses continue to build. In the corporate sector, survival has become the biggest focus.
All of which coincides with Goldman Sachs’ monthly FX analysis - this month entitled A Tricky Outlook for the Dollar.
The Goldman team, led by Jens Nordvig, thought it had detected signs of stability in the dollar over recent weeks - with the dollar’s decline slowed, in particular, by the prospect of a narrowing of interest rate differentials between the US, Europe and the UK.
But, in Goldman’s view, there are two key threats to that:
- The effect of interest rate differentials dissipates, naturally. US rates cannot continue to fall, but the currency can.
- Weak capital flows. If investors don’t want to buy US assets they don’t need dollars.
So what can help the dollar? On Tuesday, the best immediate hope seemed to be that the macro news out of Europe might be worse than out of the US. So a sharply lower-than-expected reading of Germany’s ZEW investor sentiment index was good enough to knock the euro off its recent €/$ highs…
