Dollar Continues to Slide
The fall of the dollar accelerated yesterday as investors moved back out of the ‘safe haven’ of US dollars and continued to shop for more yield. The greenback tried to stage a bit of a rally in early European trading, but has fallen back off again as I sit down to write the Pfennig.
I got a call from a Reuters reporter yesterday mid-morning to ask why the dollar was rallying at the same time stocks were moving higher. I quickly paged through my Bloomberg looking for some sign why both were heading higher. The trading pattern which has been established over the last few months has these two asset classes moving in opposite directions; good news for the US economy sends stocks higher and the dollar lower as investors retreat from defensive ‘safe haven’ positions in the US dollar. The opposite occurs whenever there are data that show the global economic recovery is faltering, stocks move lower and the dollar rallies with safe haven buying.
But yesterday morning, for a short period both were moving up. I first looked at the jobs data to see if they held any clues. The Initial Jobless claims came in slightly higher than expected, confirming our calls that the labor market will continue to be a drag on the US economy. But the reporter pointed out that continuing claims have dropped. I explained to her that the continuing claims were dropping because people were falling off the rolls. Drops in continuing claims are not due to people going back to work, but are due to people being out of work longer than the labor department’s records. So I didn’t see anything in the jobs data that would cause stocks to rally.
Unable to find anything in the data to support the short-term market movements, I moved the conversation to the longer-term trends which I feel much more comfortable speaking about. And by the time the conversation was over, the quick rally in the dollar had subsided, and the dollar index was moving back down. The short-term market movements are very hard to call, as the currency and equity markets can move on emotion and rumor for short spans of time. But they will always move back toward the underlying trend line. Right now, the trend is for the US dollar to weaken versus the major currencies, as investors begin to look for currencies with higher yields and better underlying fundamentals.
So the dollar continued to fall versus every currency except the Japanese yen (JPY). The Nordic currencies of Sweden (SEK) and Norway (NOK) led the charge versus the US dollar with Sweden moving up over 1.5% and Norway appreciating just under 1%. As I wrote yesterday, the Swedish krona has been one of the best performers recently as their economy has begun to recover ahead of mainland Europe. Sweden’s central bank, the Riksbank, was more aggressive with rate cuts than the ECB, so they will now have more room to increase them as the global economy recovers. Like Norway, Sweden went into the global recession in a fundamentally solid position, with a good trade surplus and low national debt. But Norway seems to be a bit better positioned going forward, as they rely on commodity-based exports, while Sweden is geared more toward manufacturing. Both should continue to move higher versus the US dollar.
The focus today will be on the second quarter GDP report, which will be released this morning. GDP is expected to have contracted 1.5% after a 5.5% contraction in the first quarter. If the number comes in as expected, the dollar will likely sell off as investors move back into riskier assets. But as I mentioned earlier, the currency markets have started to show signs of moving away from the safe haven/risk aversion pattern recently. Investor’s focus will eventually shift toward interest rate differentials. But I still think it is a bit too early for this shift to occur, and a stronger GDP figure will likely cause a further drop in the US dollar.
We will also see personal consumption data for the second quarter, which is expected to show that US consumers are continuing to increase savings. Consumption is expected to have fallen 0.5% after rising 1.4% during the first quarter. In spite of government efforts to stimulate spending, US consumers are worried by rising unemployment and won’t likely loosen their tight grip on their wallets anytime soon. Finally, we will end a busy week of data releases with the Chicago Purchasing Manager’s index, which is expected to show a slight increase to 43 from the 39.9 reported last week. This would be a second consecutive monthly increase, a sign that the manufacturing sector is bottoming out. Even though the number continues to move higher, any number below 50 is seen as a negative indication for the economy. Even with inventories near record low levels, manufacturers will likely wait for consumers to start spending again before increasing production.
The pound sterling (GBP) continued to rise against the dollar after a report showed British consumer confidence held at the highest level since April of last year. It seems the pound sterling has moved to an upward trend, after dropping most of last year.
The Japanese yen continues to fall versus the US dollar as investors sell the currency and move to higher yielding assets elsewhere. Japan’s unemployment rate rose to a six year high in June and consumer prices fell at a record pace. The Japanese economy continues to be stuck in a stagnant deflationary state and will be dependent on a global economic recovery to spark exports. Increasing growth in other Asian nations (mainly China) has sparked production increases by Japanese manufacturers. This has been the one positive sign out of Japan recently, but this one piece of data couldn’t halt the selling of the Japanese yen.
Elections in Japan will be held at the end of next month, and the opposition party is all but guaranteed to win. The ruling Liberal Democratic Party is in a shambles, and has produced four prime ministers in the last four years. The new government is expected to increase spending on government programs, but like the US administration, no one has figured out how to pay for these increases. The opposition’s spending proposals add up to 3.5% of GDP, and the party has ruled out raising Japan’s 5% consumption tax for at least four years. Much of the funding for the new programs will come from cutting ‘waste’ in existing spending programs (sound familiar?). Gross national debt in Japan is currently 180% of GDP and rising as the stimulus packages kick in.
Many factors in the Japanese economy are eerily similar to those in the US, and neither looks to recover quickly. Both the US dollar and the Japanese yen will continue to be sold as investors move into currencies of countries with much better economic potential. The short and medium term prospects for these two currencies certainly look negative.
Two currencies, which seem to be on a much different path than the Japanese yen are the Australian (AUD) and New Zealand dollars (NZD). Both are headed for their longest set of monthly gains since 2004. With interest rates expected to start rising, and China continuing to consume commodities that both produce, these currencies should continue to perform well. Barclays Capital raised their forecasts for both currencies saying rising risk appetite will boost demand for them in the short term. “A better than expected US GDP result would be the final icing on the cake for July and would provide great opportunity for the Australian dollar to retest 83.38 cents,” according to the report.