G-20 Greenlight for Currency Depreciation, A Redlight for U.S. Inflation, and Need for QE Decision in March

G-20'S BALANCING ACT BETWEEN PAST AND PRESENT

Last week's G-20 meeting introduced a new way of acceptably characterizing currency values. Essential message was currency movements resulting from controlling inflation/deflation or otherwise executing monetary policy mandates is acceptable. Not acceptable is currency manipulation motivated by seeking competitive advantage to only increase exports.

 

Such a position statement found balance between past G-7 member activities that resulted in currency devaluations such as U.S. and current devaluations such as Japan and Britain. With this balance also comes the awkward matter of China's almost widening range in floating its currency against the dollar. Then of course, we have a Swiss Frank that put a ceiling against the euro.

 

Past currency appreciations against other currency depreciation sets the stage for what we now see. 2010 through early 2011 saw a remarkable period for currency and equity pricing. May through June in 2010 saw the U.S. dollar start a nose dive in devaluation, from a DXY (dollar against a basket of currencies) value of some 89.00 down to around 73.00 by May 2011. A very significant period of depreciation, for the global reserve currency.

A STAGE FOR TODAY'S CURRENCY DEPRECIATION: PRIOR OTHER COUNTRY APPRECIATION

 

Accounting for U.S. dollar depreciation was primarily exceptional monetary policy easing for a second time by the Fed. This QE2 round was well anticipated by markets demonstrated through optimal positioning prior to announcements, with such positioning being signaled by currencies. Namely, where U.S. QE 1 stopped in March 2010 and equities went volatile, U.S. dollar started a considerable appreciation but went into a depreciation about three months before S&P's escalator ride up starting just prior to September 2010. In 2010, Fed spoke of QE2 at their Jackson Hole meeting, explaining the premature market movement.

 

During the same period, Japanese yen began an export hindering appreciation. This appreciation actually started in 2008 reflecting the yen as a safe haven asset against U.S. near financial collapse. Most noted is the May through June 2010 period. During this period, while a U.S. dollar devalued along with concurrent U.S. quantitative easing, a yen steeply appreciated and sustained its appreciated value until recently. Currently, the yen breaks support routinely, finding lows.

 

Same dynamic can be seen on charts for British pound. But, while the pound appreciated considerably in 2010 and into 2011, it has from 2011 until recently traded in a range. Now, pound has broke very long term support of around 1.5401 to find itself currently at 1.5230. A move of depreciation perhaps.

 

Australian dollar is getting impatient, along with its economy for a break down of its currency. But this is also a currency that experienced considerable appreciation in the same time frames as previously described currencies. Still, it hasn't depreciated like a yen or pound. New Zealand fits this role. In fact, just last week, New Zealand's central bank suggested its currency to be over valued.

 

Understanding all currencies mentioned above provides a basis for G-20 propositions of valuing currencies. That is, rounds of U.S. QE and rounds of other country QE. But what country has the strongest currency influence with commodities, interest rates and risk appetite. These combinations provide major explanations for other currencies now devaluing.

 

Due to U.S. dollars being the reserve currency and commodities priced in U.S. dollars, should the U.S. dollar dive, commodity prices increase in U.S. dollar terms.

OTHER COUNTRY DILEMMA: COMPARATIVELY CHEAP BUT RISING COMMODITY PRICES AMID MILD TO NO GDP GROWTH, OR FALLING EXPORTS

Reason for sustained to rising commodity prices against a falling dollar is a commodity will remain in demand in a global market against a falling U.S. dollar. Commodity demand results from two major influences: 1) fundamental economic demand coming from consumers and businesses needing the product, especially when dollar denominated commodity imports for countries become comparatively cheaper due to currency translation; and 2) risk appetite for buying up commodity futures, instead of holding the U.S. dollar.

This explains comparative values, or a divergence, against U.S. dollar values and global commodity values. When foreign currencies appreciate against U.S. dollars, their imports of U.S. dollar  denominated commodities are cheaper. On the other hand, their exports more expensive.

 

For U.S., despite a drop in the U.S. dollar and increases in commodity prices, we didn't see inflationary growth. Appreciation of foreign currencies is perhaps why supply and demand smoothed to prevent U.S. inflation. That is, inventories in commodities didn't increase associated with a global decline in U.S. dollar denominated asset demand. Instead, demand stayed fairly steady until an inflection point was reached in fundamental demand for the commodity. Driven by export declines.

PROPOSITIONS FOR FED DEBATING QE IN MARCH

 

That inflection point now appears to be where currency appreciation offsetting increasing commodity prices started to damage other country export potential. That time being second half 2012.

Right now, despite current U.S. QE activity, U.S. dollar isn't declining as with past QE, indicating hesitation for risk. Still, equity and commodity markets are rising consistent with past QE. Raising a warning flag is yen and pound currency depreciation. Yet to be determined is whether a race to the bottom will occur.

Some of the various currency depreciations we see now come from dollar appreciation, despite QE. Balance this with credit spreads wanting to expand, and a consistent 2012 reduction on corporate earnings expectations, and we get what looks today to be a short term pricing conundrum. Perhaps revealed by Fed agenda for its meeting in March