The Dollar Bounces - But Why?

Good day… When I signed off yesterday, several of the currencies were at or near record levels versus the U.S. dollar and the U.S. data that were going to be released didn’t look supportive. Data from the United States showed that the trade gap unexpectedly widened in February, reflecting a surge in purchases of imported automobiles, which overwhelmed record exports. The widening trade deficit indicates the U.S. dollar still has further to drop before it begins to have any impact on U.S. consumer’s spending habits.

Shortly after the trade data was released, the Labor Department said initial jobless claims came in at 357K and continuing claims rose to 2940K last week. While the initial claims were slightly lower than expected, the numbers still show continued weakness in the employment sector, which will bolster the call for lower rates in the United States. And to finish the data in the United States, we got the ISCS chain store sales, which dropped 0.5% YOY indicating consumers may be starting to tighten their belts.

Again, this data was largely negative for the dollar, so I expected to see a further drop and a move by the euro (EUR) back up to $1.60. But the opposite occurred. The dollar suddenly started to strengthen, and continued a slow climb back up until just after noon CST. The dollar index, which had traded all the way down to 71.30 was suddenly back over 72.

So what caused the big turnaround in the dollar? I searched through the news stories and called a few traders to try and figure out what caused the turn around, but no one seemed to have the answer. When I went home last night, I just figured it had to be a ‘normal’ market correction along with profit taking. But Chuck sent me an email last night with a different idea on the reason for the turn around:

“It sure looks as though the Plunge Protection Team (PPT) was out in force on Thursday, don’t you think? I mean, the dollar had fallen to 1.59 and change, and the Trade Deficit came in $4 billion worse than forecast at $62 billion… And then the next thing we see was the dollar rallying… And rallying hard. Someone with a better answer than my PPT answer is more than welcome to respond…

“As you all know, I was supposed to have dinner last night with my friend, The Mogambo Guru. His wife called me yesterday to cancel… In Mogambo style his wife said to me. ‘The Mogambo must have gotten too excited to meet up with you, he had a heart attack yesterday.’ OH MY GOD! But, Mrs. Mogambo was quick to assure me that he was OK, had a couple of stints put in, and he was already itching to go home… WOW! What a shock!

“So, needless to say, I didn’t have dinner with him last night! And… I’m so glad to hear that he’s OK…

“Don’t you all just love the conviction of the European Central Bank (ECB) and its leader, Trichet? I mean… They have a mandate to provide price stability, and come hell or high water, they are going to follow the mandate! The ECB left rates unchanged yesterday, and President Trichet, talked a tough row to hoe against inflation… Don’t you wish you had someone to watch out for your pocketbook like that? (OK, you do have me… But I’m just a little ol’ Pfennig writer, not some Central Bank President!)

“As I said earlier this week, I fully expect the Fed to cut rates 75 BPS in their next two meetings, which will leave rates here in the U.S. at 1.5%. OK… Now, let’s have the dollar put the recession and low interest rate pants on and walk down the street!

“My time here in St. Pete is up… I’m on my way back home today. The conference was good… There were a lot of new faces in the crowd, and they didn’t get a lot of my dry humor jokes, while speaking… But that’s OK…”

So the PPT was hard at work yesterday; but as usual, their efforts can only support the dollar in the short term. Overnight the dollar went back to its losing ways and dropped again. As Chuck discussed, the ECB left rates unchanged and President Trichet continued to sound hawkish in his press conference. With the euro-region inflation running at the fastest pace in almost 16 years, the ECB is reluctant to follow the FOMC and BOE’s lead. “We believe that the current monetary policy stance will contribute to bringing inflation under control,” Trichet said. “The firm anchoring of medium to longer term inflation expectations is of the highest priority.” You go to love a central banker that knows his role!

Some of the news stories I searched yesterday credited the upcoming G-7 meeting for the quick turn of the dollar. Finance chiefs from the Group of Seven are meeting today to discuss the growing economic credit crisis. The ministers have said they will discuss stronger regulation of the financial markets, but many of the dollar bulls were hoping for a coordinated action to support the sagging dollar. But reports this morning indicate there will be no intervention by the G-7 members as they have been unable to agree on a plan to pull the dollar up. As Chuck has said in the past, these meetings typically do not produce anything concrete, and are usually just a boondoggle for the central bank big-whigs to sit around and discuss just how bad things are in their respective countries while dining on a gourmet meal.

The Group of Seven hasn’t intervened in the currency markets since it supported the euro in 2000. I don’t look for anything that dramatic this time around, and apparently the markets don’t either.

So the dollar will likely continue to drift down today, as the U. of Michigan consumer confidence numbers are expected to weaken. Confidence among U.S. consumers probably sank to a 16-year low this month as unemployment continued to rise along with prices for gasoline and food. The drop in sentiment and in the general wealth of the United States middle class may finally start to weigh on spending. The resilient U.S. consumer has continued to find ways to borrow and spend, keeping the U.S. economy away from a total collapse; but with home prices falling and banks shutting down the ‘free credit’ spigot, consumers are going to have to start pulling in their free spending ways.

So I believe there is much more room for dollar weakness in the next few months. One currency that the dollar had gained on this year has finally started to appreciate again. The South African rand (ZAR) is one of the worst performers this year, falling over 12.5% versus the U.S. dollar since January first. The rand has been hit by a combination of political instability both internally and among its close neighbors. Mining, which is South Africa’s number one industry, had been hit with some strikes and power problems. While these factors are slowly being corrected, South Africa’s central bank raised interest rates to the highest level in almost five years yesterday, which should help bolster the currency. The rand is now headed for a third week of gains versus the U.S. dollar as their interest rate advantage continues to widen. Higher gold prices along with a dramatic interest rate advantage will keep the rand supported, while risk aversion and the accompanying carry trade reversals could put downward pressure on the currency. Which will win out? It will be interesting to see.

Another of the more speculative currencies has had a good couple of trading days as Brazil’s real (BRL) rose for an eighth day on Thursday. The central bank is expected to follow South Africa and increase interest rates next week. The annual inflation rate in Brazil rose to a two-year high of 4.7% in February, and the central bank will likely increase rates to make sure they keep a lid on rising prices. Brazil was the top performing currency versus the U.S. dollar last year, and should benefit from strong commodity prices and interest rate differentials. But like the South African rand, some of the real’s strength is due to the carry trade, which has proven to be incredibly volatile. Both the real and the rand should be seen as speculative investments, and should make up just a portion of your overall currency portfolio.

And I will close today’s Pfennig by talking about a currency that doesn’t get much attention, the Indian rupee (INR). The rupee has started to move back up versus the dollar over the past five or six weeks. India’s industrial production grew at the fastest pace in four months in February. Production at factories, utilities, and mines grew 8.6% from a year earlier according to the statistics office in New Delhi. This growth rate ranks India as the world’s second fastest expanding major economy, second only to China. Continued growth in India will keep them competing with China for the raw materials necessary to fuel this growth. Just another indication that the commodity boom that we have been in for the past few years is not ending. Keep buying the currencies of countries that will supply these fast growing nations with the commodities they crave!

Currencies today 4/11/08: A$ .9294, kiwi .7949, C$ .9826, euro 1.5840, sterling 1.9731, Swiss 1.002, ISK 73.21, rand 7.8497, krone 5.0125, SEK 5.9338, forint 158.92, zloty 2.1621, koruna 15.77, yen 101.18, baht 31.60, sing 1.3588, HKD 7.7892, INR 39.948, China 7.0060, pesos 10.5421, BRL 1.6850, dollar index 71.81, Oil $110.31, Silver $17.975, and Gold… $926.93

That’s it for today… That’s it for me this week, Chuck is returning home this evening. Hope he is ready for a little flashback to winter, as we are expected to get snow showers tomorrow morning. My prayers are with the Mogambo, it sounds like he came through his heart attack pretty well. I’m looking forward to spending a relaxing weekend at home, as I don’t have any major plans (no marathons to run this weekend!) Hope everyone has a Fantastic Friday and a Wonderful Weekend!!

Chris Gaffney
April 11, 2008