Why bad U.S. statistics are good for the U.S. dollar
Is there logic to Friday’s move in the U.S. dollar? Despite atrocious job numbers and indications of a deepening American recession, the dollar gained against all of its competitors except the Japanese yen.
The United States unemployment rate jumped 0.4% to 7.2% in December. In February of last year, the rate was 4.8%. In eleven months, the percentage of the work force seeking but unable to find work has increased by 50%. American job rolls shed 524,000 paychecks in December with an additional 154,000 jobs lost in October and November according to the revised statistics. Employment in all categories except health care and government declined. Bad as the December numbers were, they will probably worsen in the next three months as revisions and late reporting add to the total. The U.S. economy shed 2.6 million jobs in 2008. This was the worst one-year total since 1945, when 2.75 million jobs were eliminated as war production ended with victory in World War II.
Yet in the face of these miserable statistics, or maybe because of them, the dollar scored. The euro lost 2.2% against the U.S. currency, the British pound 1.3%, the New Zealand dollar 1.0%, the Australian dollar 1.3%. On the principle trading side, the dollar gained 2.25% against the Swiss franc and 0.7% against the Canadian dollar. Only the yen moved higher against the USD, appreciating 1.5%.
There are three rationales operating behind this dollar move, each offers a different explanation for the currency effects of the world economic situation. We can call them the trade positioning and yen cross crowd; the safe haven players; and the U.S. recovery first nationalists. For very different reasons each of these explanations boosts the dollar when U.S. economic news is poor. Perhaps it is surprising that negative economic news puts all three explanations in the strong dollar camp but the logic is not complicated.
The trading factor is simple: it is the yen crosses. Even if it makes no comparative economic sense for the yen to have strengthened four figures against the euro because of poor U.S. job figures, the reaction of the cross traders is by now an ingrained feature of the currency markets. ‘Risk aversion’ is the current shorthand for this reliable short-term trade. If economic calm is ascendant or the news is moderate, buy the crosses. If the reverse occurs, sell the crosses. Is this an image of the relative economic strengths of the Euro zone and Japan or a reflection of central bank rate policy? No. This is a straight-forward reactive trade that has worked for years. This ‘risk aversion’ selling in the yen crosses is the standard trading response to worrisome economic news. Though it is not a specifically pro-dollar trade, the over-dollar component of shorting the yen crosses supports the dollar against the euro. Selling the euro/yen weakens the euro against the dollar and the British Pound as well as the yen. That weakness is reflected in the euro U.S. dollar rate as well as the euro/yen rate.
On Friday, the movement in the euro after the Non Farm Payrolls release mimicked the yen crosses. The top in the crosses and the euro came at the same time, just after the NFP release. The percentage of the peak to trough drops in the crosses and the euro was similar: EUR/USD 2.45%; EUR/JPY 3.17%; GBP/JPY 2.77%; AUD/JPY 2.97%; NZD/JPY 2.60%. These yen crosses depreciated an average of 2.88%. The euro fell 2.45%. The EUR/USD declined 85% of the average drop in the yen crosses. In contrast, the USD/yen fell only 1.66% or 58% of the average in the yen crosses.
A much greater percentage of the drop in the yen crosses was absorbed by the euro against the dollar than was absorbed by the dollar against the yen. The dollar gained 2.45% versus the euro today but only lost 1.66% versus the yen. One could say this puts a figure, at least for Friday, on the value of the second and third rationales for dollar strength in the face of bad news. It is a measure of the combined safe haven and recovery first aspects of the competition between the U.S. dollar and the united European currency.
Another way to think about the impact of yen cross trading on the dollar is to imagine a dollar move that stemmed from a factor, which had minimal impact elsewhere -- say an unexpected Fed rate hike. Under those circumstances, you would probably see a fall in the euro against the dollar and a rise in the dollar against the yen while there might be little movement in the euro/yen.
The key fact in assessing the unequal effect of increased United States economic risk on the dollar is that U.S. Economic risk is really world economic risk and as such, it affects all currencies.
The second rationale is commonly called the safe haven or the flight to safety trade. The haven sought is comparative. There has been no country, and certainly no industrial country, that has not been touched by the recession and the financial crisis. If the U.S. economy is headed for a deep recession, the rest of the world will not escape. If the world financial system is suffering a prolonged credit drought, the U.S. has the greatest resources to overcome it. In this view, it is the U.S., with the largest and most productive economy, the world’s reserve currency and the most stable political system, that has the best chance of avoiding disaster.
The last rationale is more optimistic. The United States’ government recognized the severity of the financial crisis before any other. It has done more and is planning to do more than any other advanced economy. The economy is the first task for the new Obama administration. The Federal Reserve has been more active in gauging and surmounting the financial turmoil than any other central bank. Recessions, even depressions do not last forever. When the world economy finally turns around it will be led by the United States. Eventually U.S. economic numbers will turn positive. Will Euro zone numbers then still be mired in decline? And if they are, will the dollar commence a powerful rally? This rationale is a vote for the financial flexibility and economic potential of the United States.
It is peculiar that unrelentingly bad American economic reports serve to support dollar. But the logic does not focus solely on the U.S. but on the United States’ role in the world economy. If the world economic system is headed for years of turmoil, then the United States is best positioned to weather the disaster. If the world is plunging into a deep recession then the United States is best equipped to emerge first. These are not facts; they are the perceptions. They may turn out to be true or they may not. But for the time being, they are the rationales behind trading decisions. In the comparison between the United States and its trading collaborates the dollar still looks like the best bet to currency traders.
FX Solutions LLC
Chief Market Analyst