2001 RECESSION FAVORS DOLLAR DUE TO AGGRESSIVE FED CUTS
2001 RECESSION FAVORS DOLLAR DUE TO AGGRESSIVE FED CUTS
The U.S. slowdown of the second half of 2000 intensified in 2001, causing the economy to slip into recession, and dragging the rest of the world into a standstill. This was especially intensified by a sell-off in world stock mar-kets triggered by the burst of the U.S. tech bubble. As the U.S. imported nearly a fifth of the world’s exports, the proverbial U.S. sneeze left the rest of the world with a cold. Neither the U.S. economic contraction nor the aggressive easing by the Federal Reserve could destabilize the dollar from its top-performing position. (See Figure 3.9.)
Since the downside risks to growth were markets’ top priority, traders rewarded currencies whose central banks were boldest in cutting inter-est. GDP growth in the seven most advanced economies slowed from 4.0 percent in 2000 to 1.2 percent, well below the 2.7 percent annual av-erage of the prior decade. We see in this section how the EUR/USD bipo-larity seen in 1999–2000 took further hold in 2001 and beyond, whereby the performances between the two currencies were consistently in opposite directions. Figure 3.10 shows that the USD pairs occupied most of the top-performing pairs, while the JPY crosses reflected broadening weakness in the Japanese currency.
The U.S. slowdown of the second half of 2000 intensified in 2001, causing the economy to slip into recession, and dragging the rest of the world into a standstill. This was especially intensified by a sell-off in world stock mar-kets triggered by the burst of the U.S. tech bubble. As the U.S. imported nearly a fifth of the world’s exports, the proverbial U.S. sneeze left the rest of the world with a cold. Neither the U.S. economic contraction nor the aggressive easing by the Federal Reserve could destabilize the dollar from its top-performing position. (See Figure 3.9.)
Since the downside risks to growth were markets’ top priority, traders rewarded currencies whose central banks were boldest in cutting inter-est. GDP growth in the seven most advanced economies slowed from 4.0 percent in 2000 to 1.2 percent, well below the 2.7 percent annual av-erage of the prior decade. We see in this section how the EUR/USD bipo-larity seen in 1999–2000 took further hold in 2001 and beyond, whereby the performances between the two currencies were consistently in opposite directions. Figure 3.10 shows that the USD pairs occupied most of the top-performing pairs, while the JPY crosses reflected broadening weakness in the Japanese currency.
FIGURE 3.9 U.S. dollar retains top position in 2001 as Fed rate cuts are seen as most pro-growth policy among major central banks.
FIGURE 3.10 U.S. dollar and Japanese yen were on opposite sides of the 2001 return spectrum.
U.S. Dollar: +48 percent Contrary to conventional theory stating that currencies are favored by higher yields and vice versa, the U.S. dollar’s out-performance of 2001 resulted from aggressive rate cuts, signaling to mar-kets that the U.S. economy may be the first to recover from the global slowdown. Two business days into the beginning of January 2001, the
Fed delivered an unscheduled 50 bps interest rate cut to start a 475-point rate reduction campaign that took the Fed funds rate to a 45-year low of 1.75 percent by year-end.
Although the Fed funds rate dropped below the overnight rates of all G7 nations with the exception of Japan, the U.S. dollar outperformed all currencies in 2001. The rate cuts were insufficient to prevent 21 percent and 13 percent declines in the Dow and the S&P 500 for the year, but they proved instrumental in the dollar’s broad gains, especially as the central bank was perceived to be in the forefront of battling the ensuing recession, rather than being behind the curve. Such perception was also a result of the fact that the easing campaign included two rate cuts during unscheduled central bank meetings, highlighting the sense of urgency to stimulate the economy back into growth.
Finally, the September 11 attacks proved a minor blip in the currency radar screen, as the Fed coordinated with other central banks to inject the financial system with added liquidity. The dollar went on to rally by 3 percent in the fourth quarter in trade-weighted terms as fears inside the United States were perceived to have been largely fended off when the country took the offensive abroad to start the war against the Taliban in Afghanistan. (See Figure 3.11.)
U.S. Dollar: +48 percent Contrary to conventional theory stating that currencies are favored by higher yields and vice versa, the U.S. dollar’s out-performance of 2001 resulted from aggressive rate cuts, signaling to mar-kets that the U.S. economy may be the first to recover from the global slowdown. Two business days into the beginning of January 2001, the
Fed delivered an unscheduled 50 bps interest rate cut to start a 475-point rate reduction campaign that took the Fed funds rate to a 45-year low of 1.75 percent by year-end.
Although the Fed funds rate dropped below the overnight rates of all G7 nations with the exception of Japan, the U.S. dollar outperformed all currencies in 2001. The rate cuts were insufficient to prevent 21 percent and 13 percent declines in the Dow and the S&P 500 for the year, but they proved instrumental in the dollar’s broad gains, especially as the central bank was perceived to be in the forefront of battling the ensuing recession, rather than being behind the curve. Such perception was also a result of the fact that the easing campaign included two rate cuts during unscheduled central bank meetings, highlighting the sense of urgency to stimulate the economy back into growth.
Finally, the September 11 attacks proved a minor blip in the currency radar screen, as the Fed coordinated with other central banks to inject the financial system with added liquidity. The dollar went on to rally by 3 percent in the fourth quarter in trade-weighted terms as fears inside the United States were perceived to have been largely fended off when the country took the offensive abroad to start the war against the Taliban in Afghanistan. (See Figure 3.11.)
FIGURE 3.11 The Federal Reserve’s aggressive easing of 2001 boosted the dollar because markets’ primary concern lay primarily with slowing economic growth.
British Pound: +25 percent The sterling was the second-best-performing currency in 2001 because the Bank of England was nearly as aggressive as the Fed in cutting interest rates, slashing the overnight rate by 200 bps to 4.0 percent. Most remarkably, the United Kingdom’s GDP growth slowed from 3.8 percent in 2000 to 2.4 percent in 2001, which was still above the growth rates of the United States and Eurozone of 0.8 per-cent and 1.9 percent respectively. In fact, UK growth was highest among G7 nations in 2001. The GBP’s broad strength was also highlighted by its 5 per-cent decline against gold, which was the smallest decline of any currency behind the USD against the metal during the year.
Swiss Franc: +23 percent At a time of escalating stock mar-ket volatility, subpar global economic growth, and weak commodity prices—gold up only 2 percent and oil down 25 percent—the Swiss franc was partially boosted by its role as a so-called safe currency. The Swiss National Bank cut rates from 3.5 percent to 2.75 percent, making them the lowest behind Japan and the United States in 2001, a year when currencies thrived on the deepest of interest rate cuts. The currency also manifested its ability to strengthen in times of geopolitical uncertainty, as was the case during the September 11 attacks. Consequently, CHF lost a mere 3.1 per-cent against the dollar on the year.
Canadian Dollar: -1 percent The Bank of Canada (BoC) delivered the biggest magnitude of rate cuts behind the Fed out of the eight major central banks in 2001, reducing overnight rates by 350 bps to a 41-year low of 2.5 percent. The BoC was mindful of the repercussions of a U.S. reces-sion, especially as the United States imports over 80 percent of Canada’s oil exports. Indeed, 90 percent of the $6 dollar decline in the price of oil for the year took place after the September 11 attacks, on fears that the deteriorat-ing recession would further weigh on oil demand. Although Canada’s GDP growth tumbled to 1.8 percent from the 5 percent handle of 1999–2000, the currency fared well as FX traders rewarded the BoC’s proactive response.
New Zealand Dollar: -3 percent The kiwi finally rebounded from the bottom of the ranks, but barely generated cumulative negative returns. The Reserve Bank of New Zealand cut rates from 6.5 percent to 4.75 per-cent while GDP growth slowed to 2.7 percent from 3.9 percent. The slow-down in Japan (to 0.2 percent from 2.9 percent in 2000) and newly indus-trialized Asian economies (to 1.2 percent from 7.9 percent in 2001) created a drag on New Zealand’s economy, as they account for a quarter of the na-tion’s total exports. The year 2001 was a year of consolidation for the kiwi after a 22 percent decline in the currency’s trade-weighted index during
1999–2000. This consolidation preceded what would later become a multi-year secular rally.
Euro: -6 percent The ECB took back all but one of the 2000 rate hikes, slashing rates by 175 bps to 3.25 percent. Despite ending the year in neg-ative territory, EUR had a strong run between July and September, taking advantage of a broad summer decline in the U.S. dollar as U.S. economic data began to deteriorate. But the dollar staged a broad fourth-quarter re-bound in the aftermath of the September 11 attacks as the United States fended off the geopolitical threat and waged war in Afghanistan.
One noticeable pattern between EUR and USD developing in the first three years in the life of the young currency is the bipolarity between the two pairs. In 2001, the EUR/USD pair accounted for 30 percent of total currency market turnover, before rising to 28 percent of the total in 2004 and 27 percent in 2007. This compared to a 13 percent share of trading vol-umes for USD/JPY and 12 percent for GBP/USD. The growth in the EUR pair trading volumes accelerated consistently, rising 42 percent to $501 bil-lion in 2004 from 2001 and up 67 percent to $840 billion in 2007 from 2004. We note later in the book the intensification in the bipolarity of returns between USD and EUR and touch upon its reasons and implications.
Australian Dollar: -17 percent The high-yielding aussie ended the year as the worst-performing currency in 2001 as copper prices fell 21 percent, prolonging their sell-off after hitting 16-year highs in 2000. The global slowdown dragged G7 GDP growth to 1.2 percent from 4 percent in 2000, prompting a retreat in construction and infrastructure spending, all of which are major sources for copper. The Reserve Bank of Australia’s (RBA) 175 bps of rate cuts were the smallest among the eight currencies, with the exception of the JPY, whose central bank cut rates by merely 10 bps. Australia’s GDP slowed to 2.1 percent from 3.4 percent as newly industrial Asian economies (Hong Kong, Korea, South Singapore, and Tai-wan) struggled during Japan’s renewed dip into recession territory.
PLEASE READ ALSO : 2002 THE BEGINNING OF THE DOLLAR BEAR MARKET AND 2003 DOLLAR EXTENDS DAMAGE, COMMODITY CURRENCIES SOAR
Japanese Yen: -69 percent While 2001 rewarded currencies whose central banks delivered the most aggressive easing campaigns to tackle the deteriorating growth climate, the already ultralow rate environment in Japan meant the central bank was unable to deliver any further mean-ingful easing to stimulate the ailing economy. In March 2001, the Bank of Japan (BoJ) cut its overnight rate target to 0.15 percent from 0.25 percent, sending the actual market rate to zero percent. But the BoJ’s policy bind was underlined in the real interest rate (nominal interest rates minus infla-tion), which was higher than the nominal rate because inflation stood be-low zero. This meant that interest rates were too high for the deflationary
environment, suggesting that the BoJ was powerless in shoring up the economy with interest rate policy alone. Investors found no choice but to sell the zero-yielding JPY, especially as Japanese stocks hit 15-year lows to lose 24 percent for the year.
SUMMARY
The years 1999 to 2001 were dominated by a 24 percent rally in the USD In-dex, emerging on a combination of solid economic growth, soaring equity markets, and relatively weaker performance abroad. As the world econ-omy emerged from the Asian crisis of the late 1990s, U.S. markets provided global investors with a winning combination of safety and growth. In June 2001, the dollar index surged to a 15-year high, which was partly a result of the euro’s struggle during its early years. But 1999–2001 culminated in the end of the dollar’s seven-year bull market. As the world slipped into the 2001–2002 recession and equity markets descended in a four-year bear mar-ket, China sought to fill the void via its voracious appetite for commodities.
What followed next was the beginning of a protracted decline in the U.S. currency along with a historic recovery in the euro and commodity currencies, all of which are the subject of Chapter 4.
British Pound: +25 percent The sterling was the second-best-performing currency in 2001 because the Bank of England was nearly as aggressive as the Fed in cutting interest rates, slashing the overnight rate by 200 bps to 4.0 percent. Most remarkably, the United Kingdom’s GDP growth slowed from 3.8 percent in 2000 to 2.4 percent in 2001, which was still above the growth rates of the United States and Eurozone of 0.8 per-cent and 1.9 percent respectively. In fact, UK growth was highest among G7 nations in 2001. The GBP’s broad strength was also highlighted by its 5 per-cent decline against gold, which was the smallest decline of any currency behind the USD against the metal during the year.
Swiss Franc: +23 percent At a time of escalating stock mar-ket volatility, subpar global economic growth, and weak commodity prices—gold up only 2 percent and oil down 25 percent—the Swiss franc was partially boosted by its role as a so-called safe currency. The Swiss National Bank cut rates from 3.5 percent to 2.75 percent, making them the lowest behind Japan and the United States in 2001, a year when currencies thrived on the deepest of interest rate cuts. The currency also manifested its ability to strengthen in times of geopolitical uncertainty, as was the case during the September 11 attacks. Consequently, CHF lost a mere 3.1 per-cent against the dollar on the year.
Canadian Dollar: -1 percent The Bank of Canada (BoC) delivered the biggest magnitude of rate cuts behind the Fed out of the eight major central banks in 2001, reducing overnight rates by 350 bps to a 41-year low of 2.5 percent. The BoC was mindful of the repercussions of a U.S. reces-sion, especially as the United States imports over 80 percent of Canada’s oil exports. Indeed, 90 percent of the $6 dollar decline in the price of oil for the year took place after the September 11 attacks, on fears that the deteriorat-ing recession would further weigh on oil demand. Although Canada’s GDP growth tumbled to 1.8 percent from the 5 percent handle of 1999–2000, the currency fared well as FX traders rewarded the BoC’s proactive response.
New Zealand Dollar: -3 percent The kiwi finally rebounded from the bottom of the ranks, but barely generated cumulative negative returns. The Reserve Bank of New Zealand cut rates from 6.5 percent to 4.75 per-cent while GDP growth slowed to 2.7 percent from 3.9 percent. The slow-down in Japan (to 0.2 percent from 2.9 percent in 2000) and newly indus-trialized Asian economies (to 1.2 percent from 7.9 percent in 2001) created a drag on New Zealand’s economy, as they account for a quarter of the na-tion’s total exports. The year 2001 was a year of consolidation for the kiwi after a 22 percent decline in the currency’s trade-weighted index during
1999–2000. This consolidation preceded what would later become a multi-year secular rally.
Euro: -6 percent The ECB took back all but one of the 2000 rate hikes, slashing rates by 175 bps to 3.25 percent. Despite ending the year in neg-ative territory, EUR had a strong run between July and September, taking advantage of a broad summer decline in the U.S. dollar as U.S. economic data began to deteriorate. But the dollar staged a broad fourth-quarter re-bound in the aftermath of the September 11 attacks as the United States fended off the geopolitical threat and waged war in Afghanistan.
One noticeable pattern between EUR and USD developing in the first three years in the life of the young currency is the bipolarity between the two pairs. In 2001, the EUR/USD pair accounted for 30 percent of total currency market turnover, before rising to 28 percent of the total in 2004 and 27 percent in 2007. This compared to a 13 percent share of trading vol-umes for USD/JPY and 12 percent for GBP/USD. The growth in the EUR pair trading volumes accelerated consistently, rising 42 percent to $501 bil-lion in 2004 from 2001 and up 67 percent to $840 billion in 2007 from 2004. We note later in the book the intensification in the bipolarity of returns between USD and EUR and touch upon its reasons and implications.
Australian Dollar: -17 percent The high-yielding aussie ended the year as the worst-performing currency in 2001 as copper prices fell 21 percent, prolonging their sell-off after hitting 16-year highs in 2000. The global slowdown dragged G7 GDP growth to 1.2 percent from 4 percent in 2000, prompting a retreat in construction and infrastructure spending, all of which are major sources for copper. The Reserve Bank of Australia’s (RBA) 175 bps of rate cuts were the smallest among the eight currencies, with the exception of the JPY, whose central bank cut rates by merely 10 bps. Australia’s GDP slowed to 2.1 percent from 3.4 percent as newly industrial Asian economies (Hong Kong, Korea, South Singapore, and Tai-wan) struggled during Japan’s renewed dip into recession territory.
PLEASE READ ALSO : 2002 THE BEGINNING OF THE DOLLAR BEAR MARKET AND 2003 DOLLAR EXTENDS DAMAGE, COMMODITY CURRENCIES SOAR
Japanese Yen: -69 percent While 2001 rewarded currencies whose central banks delivered the most aggressive easing campaigns to tackle the deteriorating growth climate, the already ultralow rate environment in Japan meant the central bank was unable to deliver any further mean-ingful easing to stimulate the ailing economy. In March 2001, the Bank of Japan (BoJ) cut its overnight rate target to 0.15 percent from 0.25 percent, sending the actual market rate to zero percent. But the BoJ’s policy bind was underlined in the real interest rate (nominal interest rates minus infla-tion), which was higher than the nominal rate because inflation stood be-low zero. This meant that interest rates were too high for the deflationary
environment, suggesting that the BoJ was powerless in shoring up the economy with interest rate policy alone. Investors found no choice but to sell the zero-yielding JPY, especially as Japanese stocks hit 15-year lows to lose 24 percent for the year.
SUMMARY
The years 1999 to 2001 were dominated by a 24 percent rally in the USD In-dex, emerging on a combination of solid economic growth, soaring equity markets, and relatively weaker performance abroad. As the world econ-omy emerged from the Asian crisis of the late 1990s, U.S. markets provided global investors with a winning combination of safety and growth. In June 2001, the dollar index surged to a 15-year high, which was partly a result of the euro’s struggle during its early years. But 1999–2001 culminated in the end of the dollar’s seven-year bull market. As the world slipped into the 2001–2002 recession and equity markets descended in a four-year bear mar-ket, China sought to fill the void via its voracious appetite for commodities.
What followed next was the beginning of a protracted decline in the U.S. currency along with a historic recovery in the euro and commodity currencies, all of which are the subject of Chapter 4.
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