A colleague of mine, Jon, posed an interesting question on why it is that bad news today for the US economy (worst existing home sales number since ’99) could be good for the US dollar.
Recall now the long-awaited death of the American consumer. Consumer spending has accounted for two-thirds or more of our economic growth and also for our huge trade deficit (as Americans have kept on partying like it’s 1999 and importing more than we export). Much of that spending has come in the form of Mortgage Equity Withdrawal (MEW) as Americans have treated their homes like an ATM. That works only as long as prices keep going up. But now we all know that has reversed.
The only surefire way throughout economic history to cure a trade deficit is a good recession. So if the housing numbers keep proving worse than expected and markets hear the death knell of the American consumer, is that necessarily bad for the US dollar?
Consider that if we cut our consumption drastically, imports will go way down and possibly dip below exports, correcting our trade balance. If the same amount of investment keeps coming in to the US because investors seek the safe haven of the US during a global slowdown, then the dollar would gain value.
Throughout the economic boom of the past 5 years the US dollar has been dropping, and perhaps throughout a recession we’ll see it rise. Take a moment to think beyond the talking heads on the news and consider that one can’t have it both ways: One can’t just say about the dollar that good news is bad news and bad news is bad news.
October 24, 2007 1 Comment
October 22, 2007 No Comments
I will be going on vacation for two weeks. I will be back on September 10. Hopefully, you will be able to find some other place where you can get my kind of cutting-edge commentary until then.
August 24, 2007 No Comments
“Mrs. Watanabe†is the designation used to describe the typical Japanese woman, and she is killing the professional forex market right now. Currency analysts at places like Deutsche Bank and Goldman Sachs predicted USD/JPY to end this year around 115, or even lower. But until the catastrophic events of this past week or so, the yen has not been able to do much better 120/dollar. And much of the reason for that is Mrs. Watanabe.
Fundamentally, the yen should be rebounding. The Japanese economy is starting to emerge from its decade-long slump, and the currency should rise with it. But the overnight lending rate in Japan is still only 0.5%, making the currency an attractive borrowing option for the carry trade. And retail investors are (or at least have been, before this week) in love with the carry trade.
The Japanese retail forex market is especially important because it is bigger than the retail markets in the rest of the world combined. You can even get savings accounts in Japan denominated in something other than yen.  And in Japan, the investment decisions of the household are made by the wives. Those wives are as enamored with the carry trade as anyone else.
In July, Bank of Japan board member Kiyohiko Nishimura made a speech praising these Japanese housewives for steadying the forex market. Historically, the carry trade has always ended disastrously (although it has always rebounded from that crash) with investors across the board rushing to get out of the trade all at once. Mrs. Watanabe does not act that way, however. Every dip in USD/JPY is a buying opportunity, and as such, she reduces currency swings. It looks like the carry trade is near its end. But it was a good ride while it lasted, thanks to Mrs. Watanabe. A gnome of Zurich, she is not.
August 15, 2007 No Comments
The Japanese currency made a 5th weekly advance today against the U.S. dollar as investor appetite for risky assets has plummeted. Fear of the credit market crisis has sent the yen to its longest winning streak against the dollar since December 2004. Traders have stopped investing in risky assets with loans using cheap yen, thereby unwinding their carry trades. The Japanese currency rose .4 percent to 117.67 per dollar this morning in New York. The yen also made gains against other currencies across the board.
The biggest driver of this yen increase has of course been the U.S. subprime meltdown. Major central banks have finally taken action to alleviate the credit crunch. The European Central Bank made an unprecedented move yesterday of pumping loans into the banking system as the U.S. subprime crisis hit Europe. Yesterday, France’s largest bank, BNP Paribas SA, announced the halting of withdrawals from 3 funds. Today the ECB made loans of 61.05 billion ($83.5 billion) and the U.S. Federal Reserve pumped $19 billion into the banking system to meet increased demand for cash in the fixed-income crisis. The Bank of Japan has taken similar actions by providing loans of 1 trillion yen ($85 million).
Outlook and Strategy:
Central banks have finally felt the need to take action as U.S. subprime mortgage losses have been rippling through the credit markets. Stephen Malyon, co-head of currency strategies at Scotia Capital Inc., comments: “Subprime is clearly not contained. Concerns over the turmoil in global equity and fixed-income markets keep the pressure on the carry trade.†He does not advise betting against the yen right now.
At almost a quarter of GDP, we have finally seen the broader consequences of the U.S. housing slump affecting the U.S. economy. Paul Kasriel, chief economist at Northern Trust Corp., states: “Housing created a lot of ancillary economic activity and jobs, and now we are in the reverse process.†The problem seems to be contagious, not contained as Fed Chairman Ben Bernanke believed on March 28th. Corporations spread as far as countertop makers, railroads, and some fast-food chains have been blaming subprime for lower than expected earnings. If anybody was watching Jim Cramer’s interview on CNBC last week, his frustration with the subprime crisis could not have been more evident.
The subprime mess has spread into the major international banks, especially in Europe where many investments were made in collateralized debt markets. Shares of top 12 U.S. Banks have fallen 17 percent since June 1st. The problem began when mortgage firms, who had packaged loans into securities and sold them to investors, have hit trouble as loans defaulted diminishing investor demand. In addition, these firms had borrowed heavily from banks to buy more loans. But as the defaults increased, banks have been demanding their money back. The credit market is in a very tight spot finally receiving some liquidity from central banks.
But what does this mean for the U.S. dollar? As the Fed continues to make loans, investors will continue to turn away from risky assets. The yen may make more gains against the dollar, especially if the likelihood of a raised interest rate by Japan’s central bank increases.
August 10, 2007 No Comments
The People’s Bank of China may be in a position to use its $1.33 trillion currency reserves as a bargaining tool against U.S. lawmaker demands. Xia Bin, director of financial research at the State Council Development Center, believes China can use its holdings of U.S. government debt to its advantage. As the world’s second-largest holder of U.S. Treasuries of $407 billion, the selling of U.S. asset holdings would significantly lower their value. U.S. Treasuries fell yesterday after traders cited in a U.K. Daily Telegraph report that China may threaten to sell its holdings in U.S government debt if the U.S. imposed trade sanctions (see more in an article by Kathy Lien).
On July 26th, the U.S. Senate Finance Committee approved legislation that would place higher duties on Chinese imports. These higher duties should compensate for the undervalued yuan. U.S. lawmakers since the beginning of the year have expressed concerns that an undervalued yuan is hurting U.S. companies. The People’s Bank of China has bought huge sums of U.S. government debt in order to keep its yuan artificially low.
With a high foreign currency reserve, a central bank is able to issue more than sufficient amounts of its domestic currency to stifle demand. If demand decreases when the economy bottoms out, the central bank would have plenty of foreign reserves to buy back the domestic currency. The enormous influx of capital from its incredible trade surplus is what has allowed China to maintain the world’s largest foreign currency reserve.
Despite numbers for April and May this year showing cuts in PCB U.S. Treasury holdings after 17-months of purchases, the central bank has indicated it would cut holdings anytime soon. President Bush and Henry Paulson agree it would be “foolhardy†for China to cut holdings in U.S. debt. Selling off these assets would strengthen the yuan significantly and thereby lower export value. Both have indicated that a mutual trade flow without penalties on imports should persist. Yet, with its true actions always a secret to the public, it remains to be seen what the PCB will decide if U.S. import duties do come into play. The PCB could use its huge foreign reserves to put a dent into the U.S. economy. The situation has turned from a question of economic policy into a potential political showdown. Â
August 9, 2007 No Comments
While the euro has been beating up on the US dollar recently, the British pound has not seen fit to join in. Rather than rallying, the pound sterling has been hit by a variety of crises, including the weak global equities market and the US housing problems. The resurgence of Foot and Mouth disease in the English countryside points to a further deterioration in the pound’s standing.
The weak stock market has proved especially damaging to the financial services-driven British economy. And as credit continues to get more expensive, demand will dry up for whatever the City has to offer. New reports have also surfaced from British banks that the subprime problems in the US are starting to have a negative effect across the pond as well.
Recent economic reports from Great Britain paint a mixed picture. Retail Sales growth printed at 1.2%, the lowest level since November. Currency traders drove the pound to a two-month low against the euro and to its second straight day of losses against the US dollar. The concern in the FX market centered around worries that five consecutive interest rate hikes may be putting a brake on the British economy. But GDP growth came in at 0.8% versus 0.7% expected, suggesting that monetary policy is still accommodative to further expansion. But the market moving data out of London is the reemergence of Foot and Mouth disease, and it is this news that should strike fear into all currency traders long on the British pound.
If the disease is not contained, FMD is almost guaranteed to sink the British pound. The first reported outbreak was on August 3, and a second case was found last night. The area has already been quarantined, and a voluntary export ban has been established for England, Wales and Scotland. The last FMD outbreak cost the British economy 10 billion pounds. Meat prices rose 5% and inflation was estimated to be 0.1% higher. For the forex market, an analysis of the past is even worse. In the summer of 2001, after the first reports of contamination in the livestock, GBPUSD fell from 1.4750 to 1.3680, a drop of over 1000 pips. GBPCHF has already begun it breakdown. All those with an exposure to the British currency should be wary of the current market and keep an eye out for future developments with FMD because the disease, and what happens with it, will be the major driver of action on the pound for the time being.
August 7, 2007 No Comments
After modest gains this week, the U.S. dollar fell against the yen and euro on news of poor U.S. jobs growth. A government report today showed 92,000 jobs added for July, falling well below expectations as 126,000 jobs were added in June. Economists at Bloomberg predicted 127,000 new jobs for the past month. In addition, the unemployment rate rose unexpectedly to 4.6 percent up from 4.5. These are signs the U.S. economy is still hurting from the subprime crisis as investors are losing this week’s earlier appetite for risk. The dollar fell to $1.3727 against the euro this morning in New York, down from $1.3703 yesterday. The increase in risk aversion has also caused the dollar to fall against the yen from 119.21 yesterday to 118.93 this morning.
Poor U.S. job growth and resulting increase in unemployment may prompt the U.S. Federal Reserve to lower interest rates this year to reboot growth. This may be a sharp change in monetary policy as rates have been kept strictly at 5.25 percent for 2007. Mathew Strauss, a senior currency strategist at RBC Capital Markets Inc. in Toronto, comments: “The payroll number raised concern that the slowdown in housing may start to affect growth. It seems one supporting factor for U.S. consumers may start to lose ground—a strong labor market.†Investors betting on futures contracts on the fed fund rate due in December changed forecasts on the yield to 5.02 percent, down from 5.21 percent from a month ago. The Fed will next meet on August 7th.
Currency Outlook and Forecast:
The decisive factor for the future U.S. dollar movement is the subprime crisis. The big question bothering investors is whether the U.S. housing slump will spill over into the rest of the U.S. economy. Speaking on this issue, Jim Rogers, co-founder along with George Soros of the Quantum Fund, believes losses from the subprime-market have a long way to go. According to Rogers: “This [subprime defaults] was one of the biggest bubbles we’ve ever had in credit.†He forecasts U.S. investment banks and homebuilders will take further hits. Bear Stearns stock fell 13 percent last week. Shares in other investment banks such as Merrill Lynch and Lehman Brothers also fell this week.
Kathy Lien, chief currency strategist at FXCM, forecasts August to be a tough month for the U.S. dollar. She believes tighter credit and the housing blowup will have significant negative effects on the U.S. economy this month (see her article at dailyfx.com). Don’t expect steady long term gains in the dollar anytime soon, especially as the Fed may be lowering the borrowing rate later this year.
August 3, 2007 No Comments
Despite last week’s small gains against the euro, the U.S. dollar fell against the European currency on speculation of further weak U.S. growth. It may seem like old news, but investors fear further losses on securities backed by subprime mortgages to weaken the U.S. economy. Today, Germany’s IKB Deutsche Industriebank AG reported losses directly linked to the U.S. subprime mortgage crisis. Along with last week’s Deutsche Bank report, this indicates corporate debt to be at risk from the weak housing market. The dollar fell to 1.3678 against the euro this morning, a 0.3 percent drop from last week.
The risk of owning corporate debt has sky-rocketed, also a factor in the euro gain. Bond buyers have been demanding higher risk premiums on corporate debt as risk-aversion has increased. According to index data by Merril Lynch, the spread that investors demand on corporate debt instead of holding U.S. Treasuries has widened 20 basis points this week to 128 basis points. Investors fear corporate debt will be taking hits from the subprime meltdown.
Currency Outlook and Strategy:
Tomorrow at 8:30 a.m. the U.S. Commerce department is due to release a report on U.S. consumer spending. Economists from a Bloomberg news survey speculate personal spending rose 0.1 percent in June, the least since September. Ever since U.S. personal spending has slowed from a 5-month high in December, the dollar has fallen 3.5 percent against the euro. Even though a weak spending forecast is already factored in the EUR/USD price, there is room for a further fall if the U.S. Federal Reserve decides to lower interest rates. Kenta Inoue, economist and currency analyst at Mitsubishi UFJ Securities in Tokyo, states: “I expect the U.S. economy to slow and the Fed to lower rates in the 4th quarter. There is still room for rates to rise in Europe, so investors will start to favor European currencies over the dollar.â€
And this brings up another question: Will the European Central Bank raise their federal funds rate above the current benchmark of 4.00 percent? There is much speculation the ECB will hold onto the current rate after its next meeting on August 4th, but is likely to raise rates later in September. This increase may mean further appreciation in the euro, a main worry of French President Nicolas Sarkozy. But recent data has shown an appreciating euro has not hurt the euro-region as a whole. Exports from the EU rose 9 percent in 5 months through May from a year earlier, the second fastest pace in 6 years. This begs the question why an appreciating euro has not hurt exports. The reason is that against the currencies of the EU’s 25 trading partners, the euro has increased less than half as a much as against the U.S. dollar. Exports to the U.S. may have been hurting, but with Germany as the world’s largest exporter, exports to other countries have more than made up for losses.
Another benefit from a rising euro has been lowered costs of oil, which is priced in U.S. dollars. The price of oil has risen 26 percent this year to $76.73 a barrel today. Despite hurting some European corporations like Airbus and Peugeot (charts), the overall euro-region seems to be withstanding the euro impact. The ECB is forecasting economic growth at 2.6 percent for 2007.
July 30, 2007 No Comments
Yesterday’s report on the extremely sluggish U.S. housing market sent equities markets crashing, investors dumping corporate debt, and currency traders unwinding carry trades. New U.S. homes sales for June fell 6.6 percent. This number has jumped significantly from the 2.2 percent decrease in May. According to a Bloomberg article, this may be a no end to the real-estate slump. The housing issue has even breached the international level as a report today by the U.K.’s Nationwide Building Society showed home values to have risen only 0.1 percent in June, the slowest in 15 months.
The faltering confidence in the equities markets has also brought shifts in forex. Despite having been on a six-week run against the dollar, the pound took its biggest fall in the last five months. The pound dropped 1.0 percent in one day to $2.0305 at 1:04 p.m. in London from $2.0491 late yesterday. On July 24th the pound had reached $2.0654, its highest level since May 1981. The pound and the euro also took major hits against the yen, indicating investors are losing confidence in their carry trades with the Japanese currency. Against the yen, the pound fell to 241.27 from yesterday’s close of 243.21. Steven Barrow, chief currency strategist at Bear Stearns Intl. Ltd. in London, states: There’s a reasonable degree of panic going on with the whole mortgage and credit issue and that has encouraged risk aversion.
Currency Outlook and Strategy:
The sharp fall in the pound has allowed the 14-day RSI for the GBP/USD to fall below 70. This indicates that a reversal will not come anytime soon. Kathy Lien, chief currency strategist at FXCM expects room for more losses in the pound. In addition, traders have taken steps to hedge against the risk of a rallying yen. The cost of options protecting against gains in the yen rose to a 3 year high. This movement of risk aversion indicates a revival in the carry trade may not happen anytime soon. Neil Jones, head of European hedge fund sales at Mizuho Financial Group Inc. in London, states: Investors are looking for some short-term protection on their exposure to the yen strengthening.
History has shown us an interesting pattern where the EUR/JPY pair has followed a very similar trend to that of the U.S. Dow Jones Industrial. As the Dow takes hits so does the EUR/JPY. See more on this pattern in an article by FXCM technical currency strategist Jamie Saettele. Overall, the leveraged-buyout financing era has taken a huge fall. There is much uncertainty as investors are shifting their portfolios toward less risky assets. Steve Pearson, chief currency strategist at HBOS Treasury Service PLC in London, reflects: [The] three year period where financial market volatility has declined to low levels is over. For now it is best to let the markets react and then change strategy.
July 27, 2007 No Comments
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