Risk Aversion Has Left the Building
Friday turned out to be a beautiful day for those who have taken our advice and diversified their holdings out of the dollar. Risk aversion was placed on the back burner again, and investors moved money back out of the dollar into higher yielding currencies. The dollar and yen (JPY) got sold but all other currencies rallied, and investors also turned back toward gold, pushing the metal above $950 for the first time in over a month.
So what caused all of this confidence? First, the housing data released Friday morning in the US showed a slight pick up in both building permits and housing starts. While the housing markets have a long way to go, the data have given investors an indication that construction may have found a bottom. Not to throw cold water on investors confidence in the building numbers, but while the residential market may be bottoming out, the commercial market continues to tumble. I spoke to a good friend over the weekend who is a commercial real estate developer down in Memphis. He told me that his development pipeline has completely dried up, and even the brokerage side of his business has slowed. The only part of his business that has picked up is the marketing of foreclosed properties. He has shifted his concentration to helping banks and lenders ‘work out’ of commercial projects that they have taken back onto their books. The economy has kept most companies from opening new stores, and many under performing ones continue to shut down. My good friend tells me most of the people he talks to don’t believe the commercial real estate market will turn around until the end of next year. Not good news for the banks that are still reeling from the residential real estate bust.
But I digress. Investors weren’t focused on the commercial real estate market on Friday, they were just happy to see a possible bottom in the residential sector. Their confidence was boosted further after rumors spread that CIT would likely be saved from bankruptcy. Sunday these rumors were confirmed as it was reported that the CIT group board had reached an agreement with bondholders that should keep the struggling business lender out of bankruptcy court. According to The Wall Street Journal, the deal won’t permanently fix the company, but it buys time for the lender to restructure itself.
We have blasted the administration in the past for the way they are handling the economy, so to be fair I will have to give them kudos for the way they handled the CIT meltdown. Instead of throwing good money after bad (the taxpayers have already given CIT $2.23 billion of TARP funds), Geithner and Bernanke passed on an AIG type bailout, and even stayed away from arranging a Merrill Lynch style ‘shotgun wedding.’ Instead, they did exactly what they should have done and let the markets rescue CIT. It is still yet to be seen if the restructuring will ultimately work, but it is good to see the private capital markets are being left to their own accord, without intervention by the Fed. (Yes, I know the Fed is still involved, but not AS involved as they could have been!!)
The euro (EUR) climbed on Friday on some good economic reports. It was reported early Friday that Europe posted a trade surplus for a second month in a row. May’s trade surplus rose to 800 million euros as exports fell less than imports. The data add to evidence that commerce with the rest of the world will likely pull the euro region out of the recession. Another report showed that German producer prices fell at the fastest rate in more than 40 years last month as energy costs declined and demand weakened. The June decline of 4.6% from a year earlier was the biggest drop since December 1968. Lower producer prices are good for the European economy where industrial production rose for the first time in nine months in May and manufacturing orders in Germany increased the most in two years.
The rally by the Swiss franc (CHF) was dampened by intervention as the Swiss National Bank sold the currency to halt its rise. The sales, which occurred over the past few weeks, were the SNB’s first solo currency market interventions since 1992. While they have been able to beat back the currency markets for now, the SNB doesn’t have deep enough pockets to fight a long protracted war against the currency market. As Chuck has pointed out several times in the past, intervention can move the market in the short term, but it takes a very large amount of reserves and an iron-willed effort to fight the longer term trend. The Swiss franc will likely keep pace with the euro, as both gain versus a falling US dollar.
As investors regained their confidence, the higher yielding currencies of Australia (AUD) and New Zealand (NZD) advanced. Both currencies moved up over 1.5% versus the US dollar and hit the highest levels in two weeks versus the Japanese yen. The Canadian dollar (CAD) also rallied, completing its first five-day increase since May. A run up in crude oil helped strengthen the loonie by over 4% versus the greenback last week.
Chuck is waking up in Vancouver this morning, his favorite city located north of St. Louis. While he spent most of the day yesterday traveling, he was able to send me the following from David Rosenberg, who is usually pretty good with his thoughts.
“It is the second anniversary of the credit crunch and after all of the fiscal and monetary policy initiatives, the best we get are ‘green shoots’ and now that story is getting stale. Go back two years and you will see that the Fed Funds rate was 5.25%. Today it is zero. The fiscal deficit was 2% of GDP two years ago. Today it is 13%. Mortgage rates were 6.5%. Today they are 4.7%. Homeowner affordability with all the government measures is 70% stronger today than it was then, too. The Fed’s balance sheet then was $850 billion. Today it is bloated at $2 trillion. The government has tried just about everything. Or has it? What if we were to tell you that the one policy tool that is unchanged since the summer of 2007 is… The U.S. dollar? It is exactly the save level now, on any trade-weighted measure, as it was back then. The greenback is struggling at the 50-day moving average, and this could well be the next policy shoe to drop…”
David makes an excellent point. In spite of all of the negative numbers with regard to the US economy, the value of the dollar is basically unchanged over the past two years. This is bound to change, as US policy makers will have to let the dollar fall in order in the face of rising inflation and skittish foreign investors. As we have repeatedly pointed out, the administration has three choices with regard to the tremendous debt load that has been built up in recent years. 1) They can increase revenues (yes, they are increasing taxes, but these increased taxes are already spent on the new health care program). 2) They can decrease expenditures (big government is back, expenditures aren’t going to fall anytime soon!). 3) They can let the dollar fall in order to pay back the debt with cheaper dollars (the most likely scenario!!).
As always, we encourage you to protect yourself from the eventual drop in the value of the dollar by diversifying your investments into other currencies and gold or silver.
We start what looks to be a pretty light week of data here in the US with the Leading Indicators index, which will be released later this morning. This is the Conference Board’s gauge of the economic outlook for the next three to six months and is expected to show a slight increase. If so, it would be the first time the index has shown three consecutive months of increases since 2004. But even those that are expecting the index to show another rise are preaching caution. Most economists believe that even if the index indicates the recession is ending, recovery will be slow. High unemployment and cautious consumers will keep the US economy under pressure.
After today, the markets will have to turn their attention to the weekly jobless claims to be released on Thursday as tomorrow and Wednesday will only bring the ABC consumer confidence number and MBA Mortgage application data, neither of which are closely watched. We will also get more data on the housing market on Thursday with the release of existing home sales data. Friday will close the week out with the U. of Michigan confidence number. As I said, should be a rather slow week on the data front.