The US Dollar's "Dead Cat" Bounce?

The old trader saying is that even a dead cat will bounce if your drop it from a high enough place. After the G7 meeting in Florida, a joint announcement had the Ministers singing off the same "excess volatility in exchange rates is bad" song sheet. But with the Euro countries tiring of bearing all the forex adjustment against the dollar, the Japanese continuing to intervene heavily and continuance of "dirty floats" and dollar pegs throughout Asia, and benign neglect of the dollar by the US, traders saw little evidence of a collective will to intervene and seriously attempt to stop the dollar's depreciation. Consequently, the Euro is again pushing all-time highs, and the US dollar is pushing three and a half year lows against the yen.


The US dollar was due for a bounce, but the bounce appears to be a very short "dead cat" bounce until; a) the weak dollar has a more visible impact on the US trade deficit, and b) the FED finally begins to move to tighten monetary policy because of better-than-expected US economic performance. The US Commerce Department is now all but wild-eyed bulls on the US economy in 2004, while even normally cautious (as all central bankers are) Alan Greenspan admits the US economy is stronger than the FED believed (read, we must now begin thinking about a more "normal" monetary stance).


TT's Take The fact that Japan's current account surplus in 2003 was a new record (JPY15.79 trillion) was no help to the US dollar, nor were FED chairman Greenspan's comments that the dollar's two-year fall has caused "no material effects". One movement to keep a sharp watchout for, however is noises coming from Beijing that they are will to play ball on exchange rates. China's trade balance in January dipped into deficit for the first time in January in 10 months, while the Bank of China governor Zhou Xiaochaun was quoted as saying that "the exchange rate mechanism will be revised" this year--inciting speculation that the BoC would shift to a currency basket reference for exchange rates and away from a fixed dollar peg as early as March of this year.


If China does adopt a more flexible currency policy, forex traders believe there will be renewed pressure on the yen and other Asian currencies to appreciate--ostensibly to JPY100 and beyond. Last year we flatly predicted another challenge of the JPY79/US$ high hit in 1995-1996, but have since allowed for the possibility of an interim "bounce" in the US dollar. If the Chinese Yuan and the Asian currencies are allowed to appreciate more, the Euro could actually correct up to 10% against the US dollar.

JPY100/US$ is psychologically important for the Japanese market, and major "blue-chip" consumer discretionary Japanese exporters. Once JPY100/US$ is breached, these stocks could see an interim sell-off. But we believe that this would be a good opportunity for investors to buy these stocks because the yen never stays overbought for very long.

The Money Supply Debate

Japan's money supply, as measured by M2 plus certificates of deposit, was up 1.6% on year in January, slightly faster than December's 1.5% growth but still weak . Japan's monetary base, which is a combination of the account balance and the balance of banknotes issued, grew 13.6% on-year in January, better than the 13.2% growth marked in the previous month, but down from 16.7% growth in November and 20.6% in October.


Behind the weak growth of M2+CDs is the continued decline in bank lending, which fell 5.1% on-year in January, the same pace of decline as December. This extended the length of consecutive declines to 73 months, showing that private firms continued efforts to pay off bank loans. Although corporate capital spending is gradually recovering, private firms are funding that spending via their cash flows rather than through loans. Healthy corporate profits are also allowing companies to accelerate debt reduction.


Regarding the monetary base, the BOJ's current-account deposit target is JPY30-JPY35 trillion, but this occupies roughly 30% of the monetary base, while banknotes occupy more than 70% of the monetary base. Banknotes are slowing somewhat, despite aggressive action by the Bank. Slowing growth in the monetary base indicates two things. 1) That the bank cannot completely control the monetary base, as they simply respond to the issuance of notes according to supply-demand conditions, and 2) current account balance iquidity is likely to saturate if the BoJ tries to pump in significantlly more, since the reality is that the BoJ has merely replaced the function of the money market in acting like a money market broker.


BOJ board members maintain the view that it isn't appropriate to judge the effects of monetary easing through the money supply data alone, and Bank Governor Toshihiko Fukui said in December that it is appropriate for money supply growth to fall as a result of corporate efforts to reduce their debts.


But the debate among BOJ observers is whether or not massive currency market interventions are finding their way into the monetary base (i.e., being "unsterilized), and whether this massive increase in current account balances is actually having any favorable impact in terms of economic stimulation. Mr. Fukui seems to think so, and the BOJ's decision to bump up the ceiling to JPY35 trillion even though financial sector risk is waning and the economy is on the upswing appears aimed at ensuring the economy is on solid footing and that the BOJ continues to work to eradicate deflation in Japan's economy.


Foreign investors were encouraged when Mr. Fukui was appointed as BOJ governor last March on indications that he would implement more aggressive reflationary measures by the bank. But the bank's actions appear basically to be a continuation of the unpopular Mr. Hayami's policies.


TT's Take There is no denying that the BOJ is struggling with "experimental monetary policy", as their traditional monetary policy tools are no longer working because of the banking sector's problems, and its failure to act as an efficient transmission mechanism for monetary policy. How effective there efforts have been however is subject to widespread interpretation.