The Dollar Swings a Mighty Hammer

Good day… The dollar rallied again yesterday, and shot up even more overnight as the markets prepare for the rate announcement from the Fed. Falling oil prices helped propel the greenback higher, as oil fell below $120 a barrel for the first time since May. This latest move puts the dollar index close to 74, the point at which the last dollar correction ended back in mid-June. The technical guys are all waiting to see if the index can break through 74.31, a sign that further strength is possible. But I don’t pretend to be a technical analyst and would much rather look at the economic fundamentals to figure the direction of the dollar.

And the fundamentals in the U.S. economy still look bad. Yesterday morning we started off the week with the Challenger job report, which showed a dramatic jump in the YOY number of job cuts. This was followed by Personal Income and Spending numbers, both of which showed that resilient U.S. consumers are still spending more than they are making. Finally, the PCE Deflator was released and showed the biggest increase in prices in almost three years.

Just after the release of this first set of data, the dollar started to fall with the euro (EUR) jumping almost over 3/4 of a cent. But the euro couldn’t hold onto these gains, as the U.S. factory orders showed a surprising jump propelled by gains in petroleum and chemicals. This morning we see how the service sector of the U.S. economy is faring as we get the ISM Non-Manufacturing data released. This number is expected to stay below 50, which is the dividing line between growth and contraction. While this figure will be negative for the U.S. dollar, the afternoon announcement by the FOMC will overshadow this report.

Chuck sent me the following comments after looking over yesterday’s data:

“Did you see the outcome of the monthly Challenger job report that usually is a good indicator of the Jobs Jamboree?

“A situation that looked, at first, like it could be confined to the housing industry, really has taken a wide swath across the country with job losses. The ADP/Challenger report printed a 140.8% surge of job losses in July! This set of reports only goes back to 2000, but since that time, the job losses have only exceeded July’s number one time, at 150% during the 2001 recession.

“It’s not just construction jobs either… And I believe these job losses are just gaining momentum. Unfortunately, by the fourth quarter we could be looking at a +6% unemployment rate! UGH!

“Don’t know much about history… Don’t know much biology… Don’t know much about a science book… Don’t know much about the French I took… But I do know that job losses cause recessions, and if they’re bad enough they could cause depressions. Old Sam Cooke never thought his song would be used to make fun of dollar bulls, buying dollars in the face of huge job losses!”

I think just about everything reminds Chuck of a song! He is always able to relate just about any situation to some lyrics.

So that brings us to the morning of the big rate announcement by the FOMC. The currency markets have rallied on expectations that Chairman Ben Bernanke will sound hawkish. I’ve read a few comments by dollar bulls that suggest the FOMC will actually come out with wording to say that the risks to inflation outweigh risks to growth. The fastest inflation in 17 years certainly suggests we will see a more hawkish tone. And three members of the FOMC have been calling for an increase in rates to limit price increases. With two seats assigned to Fed governors on the 12 member panel vacant, Bernanke will have to try and craft a consensus to avoid having three of the 10 members dissent. So this certainly is setting up for a more hawkish statement.

But is this a turning point for the dollar’s long-term trend down? Or just another correction and base building before further declines for the greenback? To answer this question, I always try to dig back into the fundamentals of the underlying economies. Congressional leaders and most of the popular press would like you to believe that the huge mortgage and housing-bailout bill signed by President Bush last week will reverse the economic downturn, but it won’t.

The big boss, Frank Trotter, dropped by my desk yesterday and gave me a number of newsletters which he had finished reading. The headline of one of them really caught my eye. It was July’s issue of Strategic Investment. The headline read “BEWARE THOSE WHO SAY THE WORST IS OVER”. I couldn’t agree more.

Yesterday’s NY Times had a lead article warning about how housing lenders are now fearing a bigger wave of loan defaults. Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime credit are looking like they are beginning to level off. The article states that while it is difficult to draw precise parallels among various segments of the mortgage market, the arc of the crisis in subprime loans suggests that the problems in the broader market may not peak for another year or two. Subprime was just the tip of the iceberg, and since prime loans account for a majority of the $12 trillion market, any increase in defaults in this sector will have an even more dramatic impact.

And the housing sector isn’t the only area which is a drag on the economy. As Chuck reported in the Review and Focus a couple of months ago, the next shoe to drop in the ongoing credit crisis is consumer credit cards. Consumers, squeezed by rising energy and food prices and falling income and employment have turned to their plastic for everyday items. In years past, consumers were able to max out one card and move on to another. But banks have started to tighten up lending standards, and the number of offers for new cards showing up in the mail has declined dramatically. Banks are now predicting higher charge off rates across the credit industry, much more than previously anticipated. And like the mortgage mess, these credit card loans have been securitized and repackaged to be sold out to investors. Citigroup posted a loss due to credit-card securitizations yesterday and warned of future losses.

So the dollar is swinging the big hammer right now, and the losses on currencies are widespread. But the fundamentals here in the United States continue to tell me that this latest dollar rally will soon go the way of the other dollar corrections we have seen in the past five years.

The Swiss franc (CHF) fell to the lowest level against the dollar since mid-May, as the carry trade investors are again buying the riskier assets funded by Swiss loans. Both the yen (JPY) and franc are again being used as funding currencies for these carry trades, and they have fallen as a result. The full blown move back into the carry trades has benefited the high yielding currencies of Brazil (BRL) and South Africa (ZAR). Even the Icelandic krona (ISK) has been benefiting from a move back into the riskier assets.

The focus has moved to interest rate expectations, and currencies that are moving up are those with central banks that look to increase rates. In Europe, the currencies that have been performing the best are the ‘euro wannabes’ of the Polish zloty and Hungarian forint. Both central banks remain hawkish and have announced they will continue to raise interest rates to combat rising inflation. Investors interested in these currencies can invest into our Euro Opportunity CD which combines the Polish zloty, Hungarian forint, and Czech koruna in one index CD. These index CDs pay an interest rate of 3.19% APY for 3 months and 3.28% APY for 6 months. Additional information regarding these index CDs can be found on our website.

The Australian dollar (AUD) continued its fall last night as the Reserve Bank of Australia signaled that it may cut rates for the first time in almost seven years. “With demand slowing, the board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing,” Governor Glen Stevens said today in Sydney after keeping the overnight cash rate target at 7.25%. Currency traders took this statement as a signal that the central bank has now moved from a neutral stance to an easing bias. Weakness in the commodity markets have added to the sell off in the Aussie dollar. We don’t expect the RBA to lower rates as soon as next month, but the statement was definitely more dovish than we expected, and will continue to cause the Aussie dollar to trade off in the short-term.

Currencies today 8/5/08… A$ .9176, kiwi .7236, C$.9591, euro 1.5479, sterling 1.9536, Swiss .9480, ISK 79.24, rand 7.3762, krone 5.1822, SEK 6.1054, forint 151.85, zloty 2.0787, koruna 15.49, yen 107.86, baht 33.61, sing 1.3776, HKD 7.8049, INR 42.23, China 6.8554, pesos 9.8869, BRL 1.5619, dollar index 73.72, Oil $119.84, Silver $16.69, and Gold… $884.78

That’s it for today… I want to congratulate one of our newest members of the trade desk, John Kretchmar, who passed a securities licensing test yesterday. Good job Chachi!! My wife and two kids are heading out on a ‘float trip’ today. They will be spending the day floating down one of the many small rivers just south of St. Louis along with several of their friends. Unfortunately the temperature is expected to be well into the 90s with a heat index of over 100. But with a group of several preteens, I’m sure the paddlers will be spending a good deal of the time tipped over in the water. Hope everyone has a Terrific Tuesday!

Chris Gaffney
August 5, 2008