DXY Shows the US Dollar Was Best Performer in May

I want to start off this morning by wishing Chuck good luck with the ‘procedure’ he will be going through today. Chuck is constantly having to go in to get poked and prodded by his doctors and I am impressed at how positive he remains through all of these doctor’s visits. He told me this wasn’t a ‘big’ deal and everything should be fine, but after the past few years I think Chuck has a slightly different view than the rest of us on what a ‘big’ deal is. So we should all say a quick prayer for Chuck and his doctors.

As I turned on the trading screens this morning, I see the dollar is pretty much trading right where it was when I headed out the door last night. The headlines say the dollar has rallied in early European trading, so it must have dropped in Asia before bouncing back up as the Europeans took over. And a quick look at the DXY confirms that thought, as the index fell late last night but has jumped back up this morning. Looking at this chart reminds me of a story I read last night concerning the dollar. Bloomberg had a story that pointed to the dollar as the best performing asset during the month of May. According to Bloomberg, the dollar index posted a 2.2% increase in the month of May. The MSCI World Index of equities fell 2.45% last month, while the Standard & Poor’s GSCI Total Return Index of 24 commodities tumbled 6.89% and bonds of all types returned 1.12% on average through May 30. This was the first month the dollar index had a positive gain since November of last year, and indicates that investors are again getting nervous about the global recovery.

But this also points out the problem with using the Dollar Index as broad gauge of currency returns. The DXY is heavily dependent on the euro (57.6%), yen (13.6%), and pound sterling (11.9%). So the performance of these three currencies determines over 80% of the return of this index. A quick check of my screen shows that the Swiss Franc (CHF) was up 2.33% versus the dollar during May, and the New Zealand dollar (NZD) was up 2.24%. The trouble in Greece and Portugal certainly drove the euro (EUR) lower, and added to the returns of the dollar index. As Chuck pointed out yesterday, the competition between the euro and US dollar is a contest of the best of the worst. While the dollar index is certainly a quick and easy indicator of the dollar’s direction, investors need to remember it is heavily skewed toward the European currencies. Chuck began work on an EverBank currency index a while ago and after reading this story we may dig up the research and take it up again.

While the dollar was up versus the euro in May, the data released lately certainly doesn’t give me the ‘warm and fuzzies’ regarding the future of the US economic recovery. Data released yesterday showed that confidence among US consumers declined in May to a six-month low. High gas prices, a lack of new jobs, and a stagnant housing market have all combined to keep pessimism high among American consumers. Lower confidence will likely limit consumer spending, which accounts for 70% of the US economy. This isn’t good news for the administration, which is looking for an exit strategy for QE2. If consumers won’t (or can’t) pick up their spending, the US government will not be able to shut down their stimulus without dramatic consequences for the economic recovery. QE3 is certainly looking more like a reality.

Another report showed that home prices fell more than expected in the month of March. The S&P/Case-Shiller 20 city home price index dropped 3.6% from March 2010 to 138.16, the lowest level in eight years. Housing prices dropped 5.1% in the first quarter from the same three months last year, and the average prices are back where they were in 2002. And closing out the bad day of data for US investors was the Chicago Purchasing Managers report which dropped in May to 56.6 from 67.6 in the previous month. This is the lowest reading since November of 2009, but on the rosy side a reading above 50 still signals an expansion.

Today we will get data on the jobs front, with the release of Challenger Job Cuts and ADP Employment numbers. Economists expect both to show an increase in the number of workers being hired, but with yesterday’s disappointing numbers I think the risks are pointing lower. The ISM Manufacturing data and Automobile sales figures for May will round off the data today, so we should end up with a pretty broad-based picture of the current state of the US economic recovery.

The European recovery is slowing, as a report showed that European manufacturing growth slowed to the weakest level in seven months. Growth is slowing across the European continent, with reports from Switzerland, Denmark, and Sweden all showing slower growth. GDP in Switzerland rose 0.3% from the fourth quarter, when it increased a revised 0.8%. Economists had predicted a 0.7% increase so the actual number was well below predictions. Sweden’s manufacturing expanded at the slowest pace in 18 months with the purchasing managers index dropping to 56.1 in May from 59.8 in the previous month. Exports make up about half of output in Sweden, so the slower manufacturing growth will likely cause a drop in Sweden’s impressive 6.4% GDP growth, which was posted in the first quarter.

Both Switzerland and Sweden’s growth is slowing, but they do continue to grow; Denmark’s latest GDP numbers show it has stopped growing and has actually slipped back into recession. Denmark’s economy unexpectedly contracted for a second quarter, placing it with sickly Portugal as the only other European nation in recession. Denmark’s GDP shrank 0.5% in the first quarter following a 0.2 percent contraction at the end of 2010. Economists had expected growth of 0.5% in the first quarter.

So the Ugly contest continues, with neither Europe nor the US taking a clear lead. Investors should continue to look elsewhere for their currency investments, but alternatives are starting to be tough to find. EverBank clients know we have held a long-term belief that commodity-based currencies continue to be a good place to invest. In spite of the trouble in Europe and the US, the global economic recovery will stay on track, fueled by growth in the emerging markets. Both China and India are included in these emerging markets, even though China will soon surpass the US as the globe’s largest economy. The emergence of a Chinese consumer will continue to drive the price of raw materials higher, and the commodity producing countries should benefit.

Yesterday was a good day for these commodity currencies, with the South African rand (ZAR) leading all others versus the US dollar. The Norwegian krone (NOK), Brazilian real (BRL), New Zealand dollar, and Canadian dollars (CAD) were all higher versus the US dollar in the past couple of days. The rand has gained almost 2% versus the US dollar this week, bouncing back after being the worst performer versus the US dollar during the month of May. The rand was helped by speculators who turned toward the higher yielding currencies after Luxembourg Prime Minister Jean-Claude Juncker suggested that the ECB would reach an agreement on a fresh round of support for Greece. Another high-yielding currency that benefited from Juncker’s positive comments was the Mexican peso (MXN), which rose to the strongest level in three weeks. Both of these two currencies should be considered ‘speculative’ and can have pretty wild swings, which are dictated by events outside of their countries – risk sentiment.

A couple of commodity currencies that should be considered ‘safer’ bets are the Canadian dollar and Norwegian krone, both of which moved higher yesterday. Canada’s dollar rose the most since December, after Bank of Canada policymakers said they would eventually raise interest rates. A rising oil price also supported the loonie, as Canada is the largest exporter of oil to the US. The Norwegian krone should continue to benefit from $100 oil also, and continues to be a favorite of the desk.

And both of the commodity currencies ‘down under’ also moved higher. New Zealand’s dollar climbed to a record versus the US dollar on interest rate speculation, after a report showed that business confidence increased to a 12-month high in May. Both the kiwi and Aussie dollar (AUD) rose as investors began to feel more confident about an eventual restructuring of Greece’s debt. The Aussie dollar climbed in spite of the release of first quarter GDP which showed a drop of 1.2% from the previous three months. Economists had predicted a drop of as much as 2%, so the news was actually positive for the currency. Other reports released in Australia showed that machinery and equipment spending jumped 6% in the same quarter, so investors are looking for positive economic growth in the coming months.

Recap: According to the DXY, the dollar was the best performing asset class in May. Data released yesterday sure didn’t paint a positive picture of the US economic recovery, and reports out of Europe aren’t much better. Growth across Europe has slowed, and Denmark has actually slipped back into recession. Commodity currencies continue to be good alternatives, with several of the commodity based currencies rallying versus the US dollar and euro.

Chris Gaffney
for The Daily Reckoning