Good News for Housing is Bad News for the Dollar
The dollar lost more ground on Monday, but the reasons were different than those that caused last week’s slow decline. Currency traders sold the dollar after a report showed that sales of new homes rose the most in eight years. New-home sales in the US climbed 11% last month to a 384,000 annual pace. This was substantially higher than economists had forecast, and the most since November. The report also showed the number of houses on the market dropped to the lowest level in more than a decade. The housing numbers seem to confirm that the housing market may be approaching a bottom, but housing prices continue to fall, and more data is needed before I’m convinced the worst is over. Many of these homes have been sold to first time homebuyers taking advantage of government programs; and if unemployment continues to climb, housing sales are not likely to rise quickly.
But the housing news was music to the ears of investors, and those who had parked money in the dollar for ‘safe haven’ purposes began looking for other places to invest. Many feel the worst of the global recession is over, as global data seems to be turning positive. Adding to the good feeling on Wall Street, analysts raised their profit estimates for US companies for the first time in two years. The new optimism has many investors searching for higher yields and accepting higher risks. During the mid morning trading, the dollar index touched the lowest level this year, dropping to 78.315 before gaining back some of its losses late in the day as US stocks retreated from eight-month highs.
A report from UBS, the world’s second largest currency trader, predicts the dollar will continue to drop during the next month amid a revival in risk appetite. “Our near term bias is for further US dollar weakness,” a UBS analyst wrote. Everyone seems to be jumping on the carry trade again, which should give a lot of strength to the higher yielding currencies of Australia (AUD), New Zealand (NZD), and Brazil (BRL). This will likely be the ‘popular’ trade for investors over the next few months.
The euro (EUR) was helped earlier by a report on German consumer confidence, which unexpectedly increased to a 14-month high. German business confidence also rose more than expected this month. Lower inflation in Germany has put more money into the pockets of German consumers, and private consumption has continued to remain a significant support for the economy.
The positive news for the global economy couldn’t come at a better time for US Treasury Secretary Timothy Geithner who began talks with China. Geithner and Secretary of State Hillary Clinton will host two days of meetings, which many predict will focus on the state of the US economy. Secretary Geithner will have his “bond salesman” hat on as he tries to convince the Chinese to keep buying Treasury bills, notes and bonds. This week the US Treasury will attempt to unload $235 billion in Treasuries, so Geithner will certainly have his work cut out for him. The US debt sales will include $130 billion of T-bills, $42 billion 2-year notes, $39 billion 5-year notes, $28 billion 7-year notes, and $6 billion of TIPS.
I find it odd that the US government isn’t trying to sell more bonds out in the longer-term durations with rates being held down at these incredibly low levels. Does anyone expect US interest rates to remain at these low levels for an extended period of time? Why wouldn’t the Treasury department take advantage and try to sell more longer-term debt now, instead of loading up the majority of the issuance at the short end of the curve? I guess Geithner realizes that his job of selling all of this debt is already difficult, and trying to get the foreigners to agree to purchase longer-term maturities would be next to impossible.
Let’s hope Geithner is a first class salesman, as our economy is dependent on the Chinese continuing to buy our debt. Unfortunately his boss isn’t making his job any easier, as the deficits continue to rise. The nonpartisan Congressional Budget Office estimates the annual deficits under the administration’s spending plans will never drop below $633 billion over the next decade. And it forecasts an additional $9.1 trillion added to the debt held by the public – the amount that Geithner has to finance with bond sales. Publicly traded US debt – which excludes deficits the government owes to itself in Social Security and other trust funds – stood at 41% of the total economy in 2008. It is projected to climb to 82% of the entire economy by 2019.
The official line after the first day of meetings stuck to the pre-arranged script. Geithner pledged to rein in the US deficit to a more ‘sustainable’ level by 2013, and China agreed to try and stimulate more internal consumption. Speaking of Chinese consumption, I heard a story driving home on NPR last night that spoke about how China is spending their stimulus money. While the big infrastructure projects have grabbed most of the headlines, they have also used a large amount of their stimulus spending to stimulate consumer buying. They have issued vouchers to many of the lower income rural areas which can be turned in for consumer durables, including cars, appliances, and TVs. The increase in demand by the emerging Chinese middle class has actually caused a price jump for the panels used to make flat screen TVs. You may recall that many critics of what we write in the Pfennig regarding future growth in China stated that the Chinese economy couldn’t grow without a strong US consumer. We pointed out that even a small increase in personal wealth spread across the millions of Chinese consumers could offset some of loss of demand by the US. What we predicted seems to be coming true, as the Chinese automobile market has become the largest in the world, and markets for other consumer products like flat screen TVs seem to be following suit.
This also plays into our theory that inflation is likely to spike up after the global economy starts to recover. Inventories are extremely low, and once demand starts heating up in the western markets of Europe and the US, orders will again start flowing back into Asia. But demand in Asia will be competing with these new orders from the West, so prices will likely jump. And commodity prices have already started rebounding, including industrial metals and crude oil. Inflation is definitely lurking, and investors need to protect their holdings against a possible spike. The precious metals, or commodity-based currencies are a good way to protect your holdings.
The Australian dollar has long been a favorite of the desk, and is turning in another stellar year. The Aussie dollar rose to its highest level this year after central bank Governor Glenn Stevens said the nation’s economic downturn may not be “one of the more serious” of the post World War II era. Most economists now believe interest rates in Australia will start to rise prior to the end of 2009. The New Zealand dollar also had a gain yesterday, and headed for its fifth monthly gain in a row.
Finally, I read a story in our local paper over the weekend which pointed out that the administration has delayed the release of its annual mid-summer budget update. No doubt the update will show higher deficits and unemployment along with slower growth than projected in President Obama’s budget in February and the update in May. Typically the budget estimates are updated in mid-July, but the administration had postponed them until the middle of next month. It is not surprising that President Obama wants Congress to act on his $1 trillion dollar health care initiative before he releases the bad news of the updated budget numbers. The administration predicted that unemployment would peak at 8%, and growth next year would reach 3.2%; both overly optimistic predictions. Downward revisions to these numbers, which are inevitable, will mean that budget deficits will be much higher than the administration is now predicting. Chuck’s earlier prediction of a $2 trillion deficit this fiscal year is looking more likely with each passing day.