Dollar Falls As Bernanke Sees Rates Remaining Low

We finally got a bit of the volatility we’ve been looking for yesterday, as the markets moved dramatically as the Fed Chief testified before congress. But overnight the Asians had a different opinion and moved the dollar back up. So the currency markets were pretty much like a roller coaster ride, moving dramatically up and down but ending up pretty much right back where we started. I’ll begin where we left off yesterday, the Fed Chairman’s testimony to the House Financial Services committee.

As we expected, the Fed Chairman told the committee members that the Fed would keep interest rates near record low levels for several more months as the ‘nascent’ recovery remains fragile. The dollar immediately sold off as currency traders who had bet on an early jump in US interest rates reversed their dollar long positions. But in taking a page right out of Greenspan’s book, Bernanke tried his best to play to both sides of the House, saying, “Private final demand does seem to be growing at a moderate pace…” and telling the congressmen that the Fed will need to start tightening policy “at some point”.

But right before the Fed Chairman started speaking, the US received another piece of bad news as sales of new homes fell in January to the lowest level on record. The month on month change in new home sales decreased a whopping 11.2% in January, after falling and adjusted 3.9% in December. This was dramatically lower than the consensus forecast of economists who predicted a 3.5% increase in sales. The median sale prices also dropped and the supply of unsold homes increased. An oversupply of foreclosed homes is making it tough for homebuilders to get buyers interested.

I was talking with a realtor the other day in the gym, and he explained that some of his clients who have applied for loans on new homes were being alerted by the bank of foreclosed homes that were in the same area. Banks would much rather put a credit worthy buyer in one of their foreclosed properties instead of lending them money on a new home! And many of these banks are choosing not to pursue foreclosure on delinquent loans, waiting for their supply of foreclosed homes to be worked down before putting more foreclosures out into the market. This isn’t good news for new home builders, as they will continue to have to compete with an ever expanding supply of available homes.

But back to the currency markets… Bernanke’s talk moved the dollar lower, with even the beat down euro (EUR) showing a bit of life, trading above 1.36 for a while. But within an hour, the dollar stopped falling and started to move back up and by lunch we were pretty much right back where we had started. The reason for this reversal? The rating agencies decided to announce that they would possibly be cutting Greece’s debt rating in the next few months. S&P said yesterday that it may lower its BBB+ rating by the end of March, and Moody’s Investors Service said that it may reduce its A2 grade in the next few months. These moves will make it harder for Greece to deal with their debt, as refinancing their outstanding bonds will continue to get harder and more expensive.

And the Greeks aren’t helping themselves either! Greek unions staged another strike yesterday over the government’s budget cuts. Greek police fired tear-gas and clashed with union members in Athens after a march to oppose the Prime Minister’s drive to cut the budget deficit. It seems that the Greeks just don’t get it. Here is a quote from the president of one of the striking unions: “People on the street will send a strong message to the government but mainly to the EU, the markets and our partners in Europe that people and their needs must be above the demands of markets.” I just don’t understand how he expects his government to be able to afford to continue to borrow and spend, never having to face the consequences. After all, Greece is not the US!

The Greek problems will continue to weigh on the euro, and the ‘big boys’ certainly seem to want to take the euro lower. A story in this morning’s NY Times details how many of the major Wall Street banks have taken out huge positions in the Credit Default Swaps (CDS) market betting on a collapse of Greek economy. These CDS contracts are what threatened to take down AIG before the Treasury Secretary, backed by the US taxpayers rode in to the rescue. These big Wall Street Banks apparently decided that their strategy worked so well with AIG they might as well use it to profit from Greece’s problems.

From a story written by Nelson D Schwartz and Eric Dash in today’s New York Times: “As Greece’s financial condition has worsened, undermining the euro, the role of Goldman Sachs and other major banks in masking the true extent of the country’s problems has drawn criticism from European leaders. But even before that issue became apparent, a little-known company backed by Goldman, JP Morgan Chase and about a dozen other banks had created an index that enabled market players to bet on whether Greece and other European nations would go bust.

“Last September, the company, the Markit Group of London, introduced the iTraxx SovX Western Europe index, which is based on such swaps and let traders gamble on Greece shortly before the crisis. Such derivatives have assumed an outsize role in Europe’s debt crisis, as traders focus on their daily gyrations.

“A result, some traders say, is a vicious circle. As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that bearish signal, bond investors then shun Greek bonds, making it harder for the country to borrow. That, in turn, adds to the anxiety – and the whole thing starts over again.”

Boy does this ever stink!! Goldman and their cohorts are similar to drug dealers, who give out free drugs and then purchase medical insurance on the junkies they’ve created! But I wouldn’t bet against these guys in the short run, as they seem to be playing with a stacked deck. While I still believe the euro will pull through this crisis, the big boys have made big bets that the euro will continue to fall, so in the short term, that is exactly what will probably happen. But over time, the debts and deficits of the US dollar will cause the dollar to fall, and the euro will remain as one of the offset currencies, causing it to recover.

But back to the markets… As I left for the evening, the dollar had regained most of its strength versus the major currencies with a couple of exceptions. In somewhat of a surprise, the Swedish krona (SEK) strengthened almost 1% versus the US dollar yesterday, making it one of the top performers. Chuck also noticed the rise in the SEK and sent me this from the airport: “The Swedish kroner was the main mover overnight after the latest Riksbank meeting’s minutes showed that three members, which is equal to half of the policy committee, expect the Riksbank to begin their rate hike cycle in July… You may recall, I banged on the Riksbank for saying previously that they wouldn’t be raising rates until autumn… So much for that central bank forecast, eh? Anyway… This news underpinned the kroner, and allowed the Norwegian krone (NOK) to gain too!”

Traders in Japan took the dollar higher overnight, as they sold euros and purchased yen (JPY) and US dollars. The yen climbed up to a one-year high versus the euro as investors reversed carry trade positions. The yen moved up 0.87% versus the US dollar as Japanese investors reduced bets that the US would be moving rates higher. Traders at JP Morgan predicted the dollar would fall to 87-yen next month, another 2.5% move.

Moving on to a currency that we don’t write much about, the Indian rupee (INR). India’s economy is predicted to grow 8.2% according to India’s Finance Ministry. The Indian economy has recovered quickly from the global recession, so the government is now looking to unwind the stimulus measures it put in place over the past year-and-half. A report yesterday showed that India’s food-price inflation held above 17% for a fifth week, putting pressure on the finance ministry to work to pull in excess liquidity in order to get control over prices, which are spiraling higher. According to reports I read last night, Finance Minister Pranab Mukherjee will promise to cut the deficit to 5.5% of GDP in his budget speech tomorrow. He will also likely raise excise taxes and slow spending in an effort to shrink the budget deficit and foster sustainable growth. India is looked at by many to be a ‘junior’ China, and could be a good alternative for investors looking to diversify into the Asian currencies.

To recap… Bernanke predicts rates will remain low for ‘some time’… Greece continues to weigh on the euro, and Wall Street is positioned to profit from a Greek default… The yen is predicted to move up to 87-yen/dollar… And India looks like a good place for diversification…

Until next time,

Chris Gaffney
for The Daily Reckoning