Dollar Continues to Rebound

Good day… Chuck headed back down to Florida this morning, but this time he is bringing his entire family with him including his beautiful new granddaughter. Before heading out, he left me his thoughts on the markets yesterday:

“The dollar rally lasted another day on Thursday, but the Japanese yen (JPY) and Swiss franc (CHF) held their ground. OK… This dollar rally to me, and I could be wrong, is nothing more than a short-term technical correction. Once all the gaps have been filled in from the last fast run-up in currencies, we should be set for another blast off against the dollar. The Fed keeps cutting rates, lenders keep falling like dominoes, and the banks have stopped lending… And all the while the Grim Reaper – also known as inflation – continues to hang over us like the Sword of Damocles…

“And the next time currencies move higher, we could see another round of record levels almost daily! Again… I could be wrong… But who’s been more right so far… Me? Or Treasury Secretary Paulson and Fed Chairman Bernanke? They have far more education than I do, I can tell you that… But didn’t they… Oh, never mind, I’ve been through all their lies and videotape before!”

I sure wouldn’t bet against Chuck, but for now the dollar continues to move back up. The dollar traded at the highest level in at least three weeks against some of our favorite currencies on Thursday. The Norwegian krone (NOK), Australian dollar (AUD), and Swedish krona (SEK) were the three worst performing currencies versus the U.S. dollar yesterday. These currencies sold off as the price of commodities dropped dramatically on speculation that global demand will slow.

The main cause of the drop in commodity prices did not seem to have anything to do with supply or demand, but was a result of traders selling speculative positions as they continue to reduce leverage. The credit crisis has forced hedge funds and other highly leveraged firms to reduce their dependence on borrowed funds. With tighter lending standards, these firms have to reduce their overall positions forcing them to sell. This has caused the large correction in the price of commodities and in the price of the high yielding currencies, which were favorites of these funds.

I touched on this earlier this week when I talked about the possible correction in the price of gold. Firms will continue to have to sell profitable positions to help meet margin calls and to reduce their overall debt. This de-leveraging has given temporary relief to the U.S. dollar.

Before heading out the door last night, Chuck mentioned the staggering amount of money that U.S. investment banks borrowed from the Fed this week. The Federal Reserve, in its first extension of credit to non-banks since the Great Depression, lent $28.8 billion to securities firms over the past five days. The Fed is pumping money back into the system as fast as it can. Previously, only banks could borrow from the Fed, and it was generally frowned upon. Banks that came to the Fed ‘window’ too often would get an extra look from bank examiners. Some of this stigma still lingers for the big banks, so they weren’t rushing to the window to borrow, even after the Fed lowered rates.

So if the banks weren’t going to take the money and lend it out to the securities firms, the Fed decided to just go direct and cut out the middlemen. They opened the Fed window to firms who really need the liquidity. And since these firms don’t have much in the way of good solid assets to put up as collateral, the Fed relaxed the requirements and agreed to accept the CDOs and subprime mortgage debt that these firms have been stuck with. While the move may end up stabilizing the credit markets, it leaves me with an uneasy feeling. These securities firms are the ones who over-extended themselves in the first place and now the Fed is supplying even easier credit to them.

The Fed also bypassed its own emergency lending policies to let these securities firms borrow at the same interest rate as commercial banks. Guidelines revised in 2002 say the Fed should charge non-banks a higher rate than the commercial banks pay. But helicopter Ben wanted to make sure the money would hit the streets, so he agreed to lend to the securities firms at the same low rate as the big banks.

Its not that I disagree with the Fed’s move to help stabilize the financial markets, but I worry that all of this easy money won’t be put to good use by the securities firms. These are the same guys who engineered all of these Collateralized Debt Obligations. Now the Fed has agreed to take these CDOs as collateral. Sounds like the taxpayers are going to end up footing the bill for Wall Street excesses again. Giving these firms easy access to liquidity is like giving a junkie the keys to the drugstore. I just hope the regulators do a little better job watching these guys than they have over the past few years (but I don’t really expect them to).

And the Fed isn’t the only central bank pumping money into the system. The Bank of England joined with the ECB to loan extra funds to banks before the long Easter holiday weekend. The credit crisis in the United States is spilling over to Europe, and these central banks are taking a proactive approach to make sure they don’t have a catastrophic collapse similar to Bear Stearns.

We did get some data out yesterday as the weekly jobs numbers came in and reflected a slight rise in the number of Americans filing first time claims for unemployment insurance. The total number of Americans on benefit rolls reached the highest since August 2004, more proof that the economy is indeed in a recession. If employment continues to drop – and all indications point to a continued fall – the Fed will have to continue to try and stimulate our economy. While they may have room for one or two more interest rate cuts, what can they do after that? Nothing much but sit back and hope the downturn doesn’t last too long.

Today will be a very light trading day, as most of Wall Street has already headed out the door for a long Easter weekend. Sometimes these thin markets mean volatility, but with the credit crunch and the heightened concerns about risk, I wouldn’t look for any of the junior traders to be taking on big positions. Just more of the same. The dollar is likely to hold its recent gains, and commodity markets are likely to continue to contract.

As Chuck pointed out yesterday, these are blue light specials! If you have U.S. dollars sitting on the sidelines, I would take advantage of some of these lower prices.

Currencies today: A$ .9017, kiwi .7914, C$ .9755, euro 1.5432, sterling 1.9832, Swiss .99069, ISK 78.82, rand 8.1871, krone 5.2599, SEK 6.1023, forint 166.94, zloty 2.2874, koruna 16.495, yen 99.49, baht 31.26, sing 1.3877, HKD 7.7790, INR 40.47, China 7.0515, pesos 10.7188, BRL 1.7318, dollar index 72.747, Oil $101.84, Silver $17.12, and Gold… $919.50

That’s it for today… I want to wish Chuck an early Happy Birthday! As he said yesterday, this one will be just a little sweeter than the former. He will be spending it surrounded by his loving family, sitting in the sunshine watching his Cardinals. We got to celebrate with him here at work as he got two birthday cakes (the rest of us only get one). Hope everyone has a wonderful weekend, have fun hunting all of those Easter eggs!

Chris Gaffney
March 21, 2008