U.S. Treasury Secretary John Snow gave no signal of a shift in the U.S. dollar policy on Nov. 17 after it slumped to yet another low against the euro.

He maintained steadfast language in recent weeks when asked about the dollar, apparently ruling out any U.S. support for intervention to stem the slide in the currency.

Snow has denied the argument that Washington favors a weaker currency to help exports and the economy.

In addition, G20 policymakers made no mention of the dollar’s slide in a statement issued at the end of their meeting in Berlin, reinforcing the view that major nations have accepted the need for a weaker dollar to correct the U.S.’s trade gap.

The G20’s call for more Asian currency flexibility was seen putting more downward pressure on the dollar, according to news reports.

Financial markets had been speculating the G20, which includes the Group of Seven (G7) rich nations and big developing countries such as China, might create the kind of international accord the G7 struck in 1986 to manage major currencies.

The Chicago Mercantile Exchange electronic trading volume in November achieved a new trading record of 3.7 million contracts. This was the second time the exchange traded more than three million contracts in a single day electronically, the last time being 3.5 million contracts traded on Aug. 6.

CME electronic foreign exchange (eFX) also set a record on Friday, Oct. 27 with 270,648 contracts traded, compared to the previous overall eFX record of 236,000 set on Oct. 28. The strong volume in CME eFX was driven by a record in EuroFX futures on CME Globex of 143,331. The exchange also set a new record in CME Eurodollar futures traded on CME Globex with 2.1 million contracts.

Published reports indicate the Tokyo International Financial Futures Exchange (TIFFE) will start a forex margin trading market early in 2005. Both individuals and institutions will be able to trade on the exchange, which will begin by trading the U.S. dollar, euro, pound and Australian dollar. Traders on the exchange will have 10 times leverage (i.e., a $10,000 deposit will allow them to trade $100,000 worth of securities).

A trio of financial groups –– ABN Amro, Credit Suisse First Boston and ING –– are going to offer derivatives that will help Chinese companies minimize fluctuations in currencies. The firms are able to offer the products thanks to a loosening of financial rules by the Chinese Government. The derivatives will allow Chinese businesses to hedge against swings in the price of foreign currencies. Other firms are interested in offering the derivatives but are awaiting approval from China.

If the partnership works, the implication is many of the parties involved will have to relax their credit risk constraints. Banks that usually only trade with other banks would not potentially be trading directly with hedge funds and CTAs.

But the CME/Reuters stance is that while Reuters will provide easier access to the wider range of trading opportunities, the CME will offer credit intermediation.

The agreement offers a method of removing credit as an obstacle to the search for new liquidity and brings a regulated product to a market with an appetite for regulation. The CME operates a capital efficient market because it functions as a central counterparty (CCP) that assumes responsibility for trade clearing.

While some banks might not want to operate in that environment, the cost of capital usage, which will increase in the future, means any efficiency will be seized on. The market model of futures exchanges, with their central counterparties, is appealing to market participants, Sears says. The idea is, if this deal develops as it could, there’s a chance the spot FX world will adopt an exchange model and the CME and Reuters will be the two major beneficiaries.

“This is a whole new opportunity for [us] to get bank customers,” Sears says.

Reuters and the CME have worked together before in the development of the Globex platform. Additionally, rumors emerged in mid-November the CME is interesting in acquiring Instinet, Reuters stock-trading business, to broaden its trading reach beyond futures.

“Acquisitions and consolidation are an important part of CME’s growth strategy, but we do not comment on any specific aspect of that strategy,” says David Prosperi, spokesperson for the CME.

The partnership basically breaks down barriers between futures and spot forex market participants. Specifically, Reuters will take a market data feed from CME and convert the currency futures prices into the spot forex rates the interbank market is accustomed to using.

Reaction in the FX markets has been positive.

“It’s a good idea because more and more traders are now watching FX futures and the spot FX prices for indications and potential price action,” says Dave Floyd, trader and owner of Aspen Trading. “It reminds me of the way we used to watch the S&P futures so closely for clues on what stocks might be about to make a move.” Despite concerns by some critics that FX is too big a market for an exchange model, “it simply isn’t,” Sears says.

“The bigger it gets the better. If there were only a handful of players, they would all know each other.

Anonymity will add to the appeal of the system,” he says.

With 17,500 stations around the world, Reuters brings the mainstream interbank FX market to the partnership, while the CME contributes a different group: The CME’s customer base is 50 percent hedge funds and commodity trading advisors (CTAs).

The Chicago Mercantile Exchange and Reuters LLC are planning to open up currency futures trading to a wider customer base. And the partnership is more than just the CME displaying its market data on Reuters terminals, as some in the industry previously thought.

The two organizations have agreed to electronically connect their foreign exchange networks: the eFX futures contracts traded on CME’s Globex electronic trading system and Reuters’ Dealing 3000 system, which trades spot forex. The agreement is scheduled to go live for beta testing in December.

The partnership should have a significant impact on CME currency volume, adding depth and liquidity, according to Richard Sears, managing director for foreign exchange in the products and services division of the CME.

“We’ve displayed [our data] in spot equivalent terms,” he says. “We now quote it the way the cash [forex] markets do. It takes futures contracts and strips the interest-rate bit out so [traders] can compare futures prices to spot prices.”

The South African economy continues to expand, as Q2 growth was 3.9 percent greater than Q1. The increase marked the 23rd consecutive quarter of growth, the longest streak since the country began collecting data in 1960. According to the the South African Reserve Bank, manufacturing contributed 1 percent to the GDP, while transportation, communication, finance, real estate and business services contributed 0.7 percent each. The GDP was also buoyed by lower interest rates, a slightly higher budget deficit and favorable international terms of trade.

• Australia’s unemployment rate in September fell to 5.6percent, down 0.1 percent from May’s 5.5 percent rate, which was the country’s lowest in 23 years. The news, released just two days before the national elections, has been credited with helping secure a fourth term for incumbent Prime Minister John Howard.
  
  
• While there has been talk for months of China revaluing the yuan, The State Administration of Foreign Exchange said in mid-October there will be no change to the currency. Unlike most other currencies, the yuan is “pegged” to the U.S. dollar, meaning its value does not fluctuate regardless of the market environment. The current exchange rate is around 8.28 yuan to the dollar, which U.S. manufacturers say is weak and beneficial to Chinese-made goods.
  
  
• The Central Bank of Japan announced its “quantitative easing” policy will remain in effect until the country’s CPI has a year-on-year rate above zero percent. The easing policy keeps Japan’s short-term rates near zero, sparking economic growth as the money market becomes flooded with extra funds. However, the bank also said it would consider an inflation target above 1 percent so when the CPI did
  return to positive territory, market expectations would be stabilized and a return to deflation would be minimized.
  
  
• The Reserve Bank of India (RBI) raised its overnight interest rate — the benchmark rate in the country — by 25 basis points to 4.75 percent in late October. The RBI said high inflation concerns were the reason for the raise, although it did keep its longer-term rates on hold. That rate has held steady at 6 percent — a 30-year low — since April 2003. The RBI also cut its GDP forecast for the fiscal year ending in March 2005 to a range of 6 to 6.5 percent, down from its earlier 6.5 to 7 percent target. For fiscal year 2004, the growth rate was 8.2 percent.

• The United Kingdom saw its Q2 GDP rise 1.4 percent compared to Q1, while the country’s unemployment rate dropped 0.1 percent points from July to 4.7 percent (data is compiled every other month). The unemployment rate is a drop of 0.4 percent compared to August 2003.
  
  
• German unemployment in September stood at 10.7 percent, up 0.1 percent from the previous month. The number of new unemployed workers increased by 27,000, twice what was forecast. Economists in Germany believe the jobs number indicates companies remain reluctant to hire, even though overall economic signs have been pointing up.
  
  
• France’s annualized growth rate of 3 percent beat the euro-zone average by about 0.1 percent, according to the National Institute of Statistics and Economic Studies of France (INSEE). The INSEE credits “brisk household consumption, notably of manufacturers, accompanied by an accelerated recovery in investment” for the rise. The INSEE noted rising oil prices add uncertainty to future forecasts, and continued higher prices would “flatten the slope of the recovery without causing a downturn.”RICAS
  
• European finance ministers at the September European Central Bank (ECB) meeting agreed to not adjust fiscal rules governing the euro too radically after most central bankers asked for conservative changes earlier in the month. At a press conference after the meeting, ECB president Jean- Claude Trichet said, ”Let’s improve implementation. Let’s not change the wording of the regulation.”
  
  
• Trichet also told the European Parliament that Hungary’s government should not be able to increase its influence over the country’s central bank, as the country is proposing. Under the plan, two vice presidents of the Hungarian central bank would be removed from the council that sets monetary policy and interest rates.
  
  
• Ottmar Issing, chief economist of the ECB, told an ECB conference new members of the European Union should not adopt the euro currency until their economy is ready for it. While Issing believes use of the euro for new members will lead to further trade and financial integration, he also thinks
  countries that take on the euro too soon could lose those benefits.
  
  
• A member of the Bank of England told the BBC the UKeconomy may be growing at a greater rate than numbers released last week suggested. Although economic growth slowed to its lowest rate since the first quarter of 2003, Richard Lambert said he doesn’t believe the growth rate is as slow as the numbers suggest.
  
  
• In late October, Turkey revealed its new currency, which will go into circulation on Jan. 1, 2005. The new lira comes after 30 years of economic crisis, including hyperinflation for much of the 1990s, although the inflation has eased somewhat since exceeding 100 percent in the mid-1990s. The government hopes the new currency will stabilize things.
  
  
• The Economy Ministry of Spain said in late October it is keeping its GDP target for 2005 at 3 percent, up from 2.8 percent in 2004. Deputy Prime Minister Pedro Solbes targeted oil prices as a reason for the increase, although he opposes any cuts in fuel tax and instead favors reduced use of oil products.

The Group of Seven repeated a call for more currency flexibility at its last meeting beginning Oct. 1, but did not raise pressure on China to revalue its yuan.

This lifted some weight from the dollar, which was driven down before the meeting. Any move by China to free the yuan — now pegged to the dollar at a level many analysts see as too low — would be expected to put downward pressure on the U.S. currency.

The G7 repeated language used at a meeting last February, reaffirming exchange rates should reflect economic fundamentals and calling for currency flexibility.

In addition, during the meeting the G7 warned high oil prices pose a risk to the global economy, but the economic outlook for 2005 was still favorable.

Chicago Mercantile Exchange, Inc. and Reuters announced in October the seven banks and
futures clearing firms to participate in the launch of CME FX on Reuters.

They are: ABN AMRO; Bank of America; Barclays Capital; HSBC; Royal Bank of Scotland; kandinaviska Enskilda Banken (SEB); and Societe Generale Group members, Societe Generale and Fimat International Banque SA.

Beta testing is expected to begin by the end of Q4 2004, with the launch shortly afterwards.

CME FX will provide Reuters’ global customers with access to CME’s electronic foreign exchange (eFX) markets in a spot equivalent format. The agreement, introduced in May, marks the first major linkage of sell side traders in the interbank FX market to CME eFX futures markets.

The service will be initially available in the United Kingdom and U.S, with later rollouts to other European, Asian and North American markets. Both in-house FX traders and clearing firms for nonmember Reuters customers will be able to trade CME eFX futures on Reuters flagship foreign exchange trading platform Reuters Dealing 3000.

Activity was also strong for euro denominated contracts, up by 100 percent.

Business in euro-denominated interest rate swaps expanded by 66 percent. In terms of market size, contracts denominated in euros remained larger than those in dollars — $461 billion vs. $347 billion.

After decreasing between April 1995 and April 2001, activity in yen-denominated interest rate swaps expanded by 119 percent, to $35 billion. According to the BIS, the growth may reflect the signs of economic recovery and the associated changes in the outlook for interest rates.

Activity in pounddenominated interest rate swaps was also up by 157 percent, to $59 billion. Turnover in foreign exchange derivatives — or currency options — was up by 109 percent, to $140 billion. A currency option provides a trader with protection against adverse movements in foreign exchange rates. The share of this segment of the OTC derivatives market remained around 12 percent. Activity was boosted by contracts involving the U.S. dollar (up by 104 percent, to $110 billion), especially the
dollar/euro and the dollar/yen pairs (up by 124 percent and 58 percent, respectively). Turnover also increased for other euro-denominated contracts, by 130 percent, to $23 billion.

Looking at the counterparty breakdown, turnover with other financial institutions rose to 43 percent of global OTC derivatives turnover, up from 29 percent in April 2004.

Between 2001 and 2004, there were no substantial changes in the composition of the FX market.

The U.S. dollar was on one side of 89 percent of all transactions, followed by the euro (37 percent), the yen (20 percent) and the pound (17 percent). It shows the U.S. dollar/euro continued to be by far the most traded currency pair in April 2004, with 28 percent of global volume, slightly less than in 2001,
followed by U.S. dollar/yen with 17 percent (20 percent in 2001) and U.S. dollar/pound with 14 percent (11 percent).

The share of trading in local currencies in emerging markets increased slightly to 5.2 percent.

In the OTC derivatives market, average daily turnover increased by 112 percent between April 2001 and April 2004, to $1.2 trillion at currentexchange rates. The OTC market section consists of “non-traditional” foreign exchange derivatives — such as cross-currency swaps and options — and all interest-rate options.

“What surprised me was the large increase in derivatives trading,” says Osman Ghandour of The Forex Edge. “It appears the forex market is attracting a higher level of speculative fever — always a dangerous sign. “However, what’s more, I think participants have become more sophisticated in trading crossrates, which also adds to the turnover,” he continues. Bank of New York’s Woolfolk also
sees speculative trading as a significant factor in the forex market.

“Currency is now traded as an asset class more so than at any time in the past, and such speculative interests have undoubtedly boosted FX turnover,” he says.

Business in interest rate contracts grew by 110 percent. The increase was driven especially by trading in dollardenominated instruments, which were up by 128 percent, according to the survey. Activity was intense for dollardenominated options, with turnover up a whopping 675 percent.

Because of this jump, trading in interest rate options represented 17 percent of total trading in interest rate products — a threefold increase over April 2001. “If you look at the breakdown of the increase, the largest component is not the spot market, but rather FX swaps, although all three components — spot,
outright forwards and swaps — all posted gains year over year,” says Dave Floyd of Aspen Trading, an FX trading and research firm.

According to the survey, trading between banks and financial customers (such as hedge fund managers) rose, and its share of total turnover went up from 28 percent to 33 percent. The survey said the higher activity between reporting banks and financial customers may reflect a sizeable
increase in activity by hedge funds and commodity trading advisers, as well as robust growth of trading
by asset managers (money managers). Between 1998 and 2001, when the last survey was taken, activity in that market segment had been driven mainly by asset managers while the role of hedge funds had declined.


“There are two contributing factors driving the BIS-reported increase in daily turnover in the foreign exchange market,” says Michael Woolfolk, senior currency strategist with Bank of NewYork. “First, the prior tri-annual figure was reduced by the launch of the euro and subsequent elimination of high volume European cross currencies such as the Deutsche mark/French franc (DEM/FRF) and Deutsche mark/Italian lira (DEM/ITL). Given the growth trend in FX turnover during the preceding decade, this number would have been closer to $1.7 trillion without the launch of the euro.

“Second, the current tri-annual turnover figure reflects an acceleration in the velocity of foreign exchange transactions as hedge funds and other speculative trading interests play a larger role in the market,” he adds. The survey reveals trading between reporting dealer banks rose between 2001 and 2004, although its share continued to fall, from 59 percent in 2001to 53 percent in 2004.

According to theBIS, restraining factors might included the continuing consolidation in the banking industry, as well as efficiency gains derived from the use of electronic brokers in the interbank spot market.

The share of trading between banks and non-financial customers edged up slightly to 14 percent.
“[Interdealer shrinkage] is actually a testimony to individual customers,” says Glenn Stevens of FX brokerage Gain Capital. “They’re bypassing the banks and going to market makers like us. Also
the onset of electronic trading has contributed. Price discovery is a lot closer.”

A global reserve bank survey confirms what many in the market have suspected: The FX market has grown immensely over the past three years.

The much-anticipated Bank for International Settlements (BIS) Triennial Survey of FX Market Turnover or 2004, released Sept. 30, revealed average daily FX turnover (the value of trading volume) rose from $1.2 trillion in 2001 to $1.88 trillion in April 2004, a 57-percent increase at current exchange rates and a 38-percent increase using 2001 exchange rates.

The triennial report by the BIS, based in Basel, Switzerland, said the rise followed a surge in interest from hedge funds and asset managers.

The 2004 survey shows a large increase in activity in traditional foreign exchange markets compared to 2001. Turnover rose across instruments, but particularly in the spot and forward markets, according to the BIS.

In addition to valuation effects, factors boosting turnover include individual trader and investor interest in foreign exchange as an asset class alternative to stocks and bonds.

Although most major currency pairs traded listlessly as summer came to a close, the British pound managed to send a few sparks flying as it tumbled in value relative to other major currencies. It reveals the three largest percentage moves (on a closing-price basis) in the major currency pairs from Aug. 2 through Sept. 15 came at the pound’s expense, with the pound trading around $1.78 U.S. in mid-September. The euro was the greatest beneficiary of the pound’s weakness, with the euro/British pound (EUR/GBP) rate rallying nearly 4 percent. In late September the market was meandering just below the level of its March 12 high.

It shows the EUR/GPB has essentially traced out a more volatile trading range than most other currency pairs, especially those involving the Japanese yen; the USD/JPY and EUR/JPY rates were especially moribund from mid August through mid-September.

It shows one exception — the British pound/Japanese yen (GBP/JPY) rate. The pound lost almost as much (-3.38 percent) relative to the yen as the Euro gained against it in August and the first two weeks of September. Similar to the situation, the pound bounced a bit after slightly exceeding (but not closing below) the June 24 low. After the brief rally to a high of 198.60 on Sept. 13, however, the GBP/JPY rate pulled back and began to consolidate.

Trend. The market environment also includes the long-term trend of the exchange rate. It shows the euro/U.S. dollar (EUR/USD) spot rate. The price data is inverted to reflect the dollar’s value. The downtrend started July 6, 2001, and has lasted more than three years so far, punctuated by corrections.

Notice at the end of the chart the dollar made a higher low in June, which is connected to the February low by an upward-sloping support line. Price is above the long-term linear regression line (see “Indicators in the issue,” p. 58), too. This up move in the dollar started in April — just when high U.S. first-quarter growth started to sink in. Is the most recent up move another correction that could turn into a trend reversal? The downward environmental bias is very strong, so it will take powerful cyclicals or other factors to overcome it.

Strangely enough, a powerful factor could be price moves themselves. The FX market, like other markets, watches itself. Market action is a factor in the next market move, independent of structural and cyclical concerns — a feedback process George Soros referred to as “reflexivity.”

A very high percentage of FX traders depend on technical analysis of one stripe or another, including ideas such as the exhaustion of a trend pattern. It may seem strange to include technical factors in a list of market sentiment determinants, which we normally would think of as “fundamentals,” like the current account deficit or GDP. But in practice, FX technical factors can be as weighty as the cyclicals in any given period — and a big enough technical trend change can alter perception of structural conditions, too.

In other words, we think of the technicals as reflecting fundamentals, but we have dozens of fundamentals, so sometimes a technical driven change forces us to shift our perception of which fundamentals are the important ones. Technicals don’t “influence” the fundamentals, but they influence how much relative weight we give them.

Institutional factors include the few tidbits of “dollar policy” that sometimes fall from the lips of the Treasury Secretary, but mostly the institutional component is all Fed, all the time.

In July 2004, for example, the Fed chairman asserted any soft spots in the economy were transitory and the market should expect “measured” rises in the Fed Funds rate that would normalize interest rates to a level appropriate to a full and sustainable recovery. And in mid-September, the Fed dutifully raised the Fed Funds rate for a third time.

Exchange rates are also correlated (at least sometimes) with the interest rate differential, so again it was only rational to wonder if the long dollar downtrend might be ending when the Fed began raising rates. As the Fed started making hawkish noises, for example, the high-yielding currencies softened and the dollar was purchased as traders unwound some “carry trades” (see “Getting a lift from the carry trade,” p. 32).

Political factors, including foreign affairs, are another component of the environment. One of the dollar’s corrective up moves occurred in March 2003 when the U.S. invaded Iraq. Overall, the situation in Iraq is an environmental negative, chiefly because other countries are critical of U.S. policy. For example, when the Madrid train bombing occurred on March 11, it was the dollar that fell, not the euro.

This would appear to be a strange reaction unless you understand that any act of terrorism — even if it takes place in another country — is now dollar- negative. Not surprisingly, the outcome of the presidential election is sure to impact the dollar.

News. The news is meaningful only in the context of already-existing market sentiment. One or two good numbers, for example, don’t change an overall negative bias, just as a few bad numbers won’t make much of a dent in a positive bias. A string of all-bad or all-good numbers can cumulatively do the job, though.

News comes in two flavors: regular daily news that turns the market-sentiment dial toward bullish or bearish, and “event”-type news that changes everything. Both garden-variety and event-type news influence the environment and are in turn influenced by it; it’s a complex interactive process. When you hear consumer confidence is way down, for example, you expect retail sales to fall, and since the consumer is two-thirds of the U.S. economy, you expect GDP to fall, too. As noted earlier, exchange rates are correlated with growth rates. When consumer confidence falls in the U.S., the knee-jerk reaction is to sell the dollar.

Ah, but will the selling prevail? It depends on whether the market sentiment was biased in favor of the dollar or against it before the release.

In terms of garden-variety news such as consumer confidence, let’s say the current consensus view has been generally favorable to a particular currency, and now the currency-negative news comes out. The price seesaws back and forth while traders absorb the information, but if the news is not jarring and can fit without too much effort into the prevailing consensus, the existing trend or directional bias will usually win in the end.

In fact, a dip on bad news actually constitutes a buying opportunity and the bulls will quickly put themselves back in charge — which is what happened after the end of the initial hot war period in Iraq. The war itself was long-anticipated and the market bought the dollar on the news, but the U.S.’s swift dismantling of the Hussein regime was not a strong enough factor to overcome the existing negative bias for more than a brief period.

Event news operates on a different scale altogether. It can be scheduled news, such as the employment report, or it can be an out-of-the-blue shock, such as the Sept. 11, 2001, terrorist attacks. News that rises to the “event” level is by nature wildly different from the consensus estimate, such as when payrolls come in at 32,000 when they were forecast at 225,000, which was the outcome on Friday, Aug. 6. When an event is bizarre enough (and such a low payroll level was bizarre), it becomes an event shock almost on a par with an out-of-the-blue shock.

An event shock changes everything because it doesn’t fit into an existing cyclical scenario. Payroll growth of only 32,000 compared to an average of some 124,000 over the previous three years means expectations of future payrolls numbers are going to be less trustworthy than usual and, therefore, so will data on consumer sentiment, spending, retail sales and a host of other fundamentals. Any hope the cyclical data would overcome the environmental negative bias is now out the window. In this case, the payroll event reinforced the negative bias in market sentiment.

Market sentiment may seem like a vague concept, but when you take it apart, you see it consists of specific fundamental and technical components that interact to generate a bias for a currency, either favorable or unfavorable. The bias comes from the overall environment, and perception of the environment will color the news.

At any one time, a majority of FX traders agree on the bias even when they disagree on everything else. In terms of the components of the environment that establish market sentiment, there are big picture factors and little-picture factors.

Structural conditions. The biggest factor in the market environment that establishes sentiment is an economy’s collection of “structural” conditions. In the U.S., the most important structural issue is the current account deficit, which will be 5.4 percent of GDP this year and perhaps more — an unprecedented level in a developed country. Most analysts say this is unsustainable, a conclusion cited for the dollar’s three-year decline that started in July 2001. It was clear even then that once the current account deficit got on the radar screen, it would be very tough to get it off. At the time, the deficit was 3.5 percent of GDP, and it has deteriorated exactly as expected. That’s the whole point of a structural problem — it’s the elephant in the living room.

Another structural element is the budget deficit — but it’s a lot weaker, because the free-market character of the overall economy suggests the U.S. can earn its way out of it. Fixing the current account imbalance would require other nations to do things they show no inclination of doing, such as China and other Asian Tigers un pegging their currencies from the dollar and Japan leveling the playing field for U.S. imports.

In Japan, the big structural issues are the too-high savings rate and too low consumer spending level (twin roadblocks to ending deflation), along with a risk-averse and ailing banking sector that will not lend and allow the multiplier effect to work its magic.

In Europe, the key structural condition is the rigid labor market. When a few big European companies such as Siemens) won longer working hours without higher pay in a settlement with the unions, the euro benefited immediately. Everyone knew right away this was news that modified the key structural concern.

Cyclical data. Cyclical data, which consists of the regularly reported economic factors such as GDP, trade balances, producer and consumer prices, retail sales, etc., must be evaluated in the context of structural conditions. Except for a few big items such as GDP growth, cyclical data that is not relevant in the context of current structural conditions tends to be ignored.

For example, when it was evident Japanese GDP was growing faster than U.S. GDP in Q4 2003, it was a wake-up call because such high growth, not seen in a decade, potentially signaled the beginning of the end for Japanese deflation.

The yen got a boost from the Q4 and Q1 GDP reports as the structural bias was being revised — but then took a header when Q2 GDP was low, and low specifically because the domestic demand component of GDP was soft.

Similarly, in the U.S., the dollar took a bath in early August when the non farm payroll number (part of the monthly employment report) for July came in abnormally weak — even though payrolls are not correlated with any other important cyclical indicator — because the market had become obsessed with payrolls as a symbol of growth.

Foreign exchange rates are correlated with growth, so the U.S. recovery in recent quarters gave birth to the perfectly reasonable idea that the three year dollar downtrend might be coming to an end. However, if this proves to be the case, it would be a triumph of cyclicals overcoming a deep, unfavorable structural bias — a very tough thing to achieve.

The World Bank increased its loan to India’s new government by about $1 billion in August, earmarking the money for the country’s poorest four states. India will receive the raised loan allotment, equal to $3 billion a year, from 2005 to 2008.