US Dollar Rises on QE2 Theories

It was fairly uneventful in the currency market yesterday, but the dollar held the hammer at the end of the day, as there were only two currencies that posted gains. I’ll jump into currencies in a moment, but first, we’ll take a look at the results of the economic reports released here in the US. Right out of the gate, we had the TIC flows (security purchases by foreigners), Industrial Production, and Capacity Utilization, which were then followed by a measure of housing.

The net long term TIC flows for August were more than double the July figure, coming in at $128.7 billion compared to $61.2 billion, however, the total net TIC flows fell to $38.9 billion. The total net figure takes into account short-term securities, and as Chuck mentioned yesterday, the markets used to focus on this piece of data but it seems to have fallen out of graces.

Looking back to August, we saw the dollar enter into a sustained weakening pattern only taking a break later in the month so incentive to buy US Treasuries by foreigners would be higher rates, which we’re not going to see for quite some time, or cheaper prices via the dollar. As the dollar weakens, foreigners can buy Treasuries at a discount and that coupled with bouts of flight to safety would be the main reasons for any increases in this figure.

China increased their holdings by $21.7 billion in August to $868.4 billion and remains in the top spot, followed by Japan raising their stake to $836.6 billion. Looking specifically at Treasury notes and bonds, total foreign purchases amounted to $117 billion in August, compared to $30 billion in July, and is what’s needed to finance our debt.

Moving on to September Industrial Production, we saw the figure disappoint by falling 0.2% and marked the first decline since June of last year. It was expected to gain 0.2% but we’ll see in the coming months if this becomes a trend or if foreign demand for US product will pick up the slack. And remember, a weaker currency is good news for exports.

The closely related Capacity Utilization figure, which is a percentage of plant use, came in a bit lower than expected. The September number dropped to 74.7%, from the revised and estimated September number of 74.8%, so nothing of any great significance. Just to give some type of perspective, Capacity Utilization has averaged about 80% over the last two decades so there aren’t any inflation pressures peeking through on this front as of yet.

And looking at the final data release from yesterday, we had the October NAHB Housing Index surprise on the upside by rising to 16 from 13 in September. This measure is simply a gauge of homebuilder confidence and has risen a bit from its record low of 8 in January 2009, but still remains in the cellar. Although this number is second-tier data, I just don’t see any sustained improvement in housing until the employment picture brightens significantly.

I know looking at these numbers can be pretty dry sometimes, so I’ll try and get through it as quickly as possible. Due first thing this morning, we have September housing starts and building permits on the docket and both aren’t expected to show any bright spots. Housing starts are expected to slow a bit to 580K and building permits are forecast to rise slightly to 575K… In other words, nothing really to see here. The only other report due is a consumer confidence measurement released late in the day, and unless there is any large swing one way or the other, it will most likely be swept under the rug.

As I mentioned above, the US dollar gained strength throughout the day as traders try to guess when and how much stimulus the Fed plans to pump in with QE2. With the Fed remaining tight-lipped, rumors keep floating around that more money than expected will be added to the economy, and yet, others think they have the inside track and are calling for less.

Taking it one step further, we have those who believe it will be added incrementally and those who believe it will be added in one swoop. It’s been a constant tug-of-war and those who anticipate a lower addition of stimulus were winning yesterday causing a rise in the dollar. We also had Geithner speaking yesterday, which was dollar positive.

Basically he said that the US would preserve confidence in a strong dollar and will not engage in currency devaluations. That rhetoric is great and everything, but we’ve heard this before and its obvious the US isn’t in a position to maintain and support a strong currency. There were a lot of short dollar positions that have built up over the past several weeks, so some traders might be looking for any excuse to buy dollars at the moment. Again, the direction of the dollar lately has been tied to market perception of future QE.

There were only two currencies that gained yesterday, which were the Mexican peso (MXN) and Japanese yen (JPY), as they primarily rode on the coattails of the USD. We haven’t talked too much about the peso lately, but there really isn’t anything attractive at this point so it rose on thoughts additional stimulus would give a boost to economic growth in the US. Again, not exactly a reason to get excited about the peso, especially with doubts as to how much contribution this would actually provide to the US economy.

The Japanese yen gained just under 0.25%, not necessarily on any merit of the underlying economy, but just on the general buying of dollars. We keep flirting with the post-World War II high of 79.75 as it traded into the 80 handle yesterday, so as you can expect, rumors of additional intervention from the BOJ could start flying around again.

Moving on to one of our favorite currencies and the worst performer yesterday, the Norwegian krone (NOK) lost 0.75% on the day. There wasn’t anything specific other than dollar strength to push the currency lower, but just looking bigger picture, the krone hasn’t seen the same kind of appreciation that the Australian dollar (AUD) or even the Swiss franc (CHF) have seen so far this year. Norway has the fundamentals that being a commodity-based currency and a surplus economy use to provide future support. And not to mention, a central bank that still has room for higher rates.

Today, the Bank of Canada meets on rate policy and they are fully expected to keep them on hold for the moment. All eyes will then focus on the statements released afterwards to see if any hints are provided on future direction as well as the tone policymakers may leave with us. The loonie briefly broke through parity late last week but has sold off a bit to between 0.99 and 0.98. The internal economy could probably stand a hike, but external factors don’t make a likely scenario.

Before I let you go today, Brazil is back in the news as they are trying everything to stem their currency’s appreciation. The Finance Minister announced they will increase a tax on foreign investment in fixed income securities to 6% from 4% and a tax on margin deposits for the futures market is expected to climb to 6% from the current 0.38%.

Neither one of these policy changes impact our EverBank Brazilian CDs, but this is just another attempt to cool speculation on the real (BRL) and make it somewhat less attractive to purchase. At the end of the day, these higher taxes and government intervention in the market won’t offset their interest rate differential and the overall market appetite for the currency. In the end, the market as a whole usually wins.

Lastly, an Australian policymaker said the Aussie’s rise to parity last week reflects the strength of the underlying economy and they have no intention of intervening in the currency market. They said government efforts to try and lower the currency’s value would encourage retaliation from trading partners and that’s not in the best interest of their export industry. Finally, a central banker using logic.

As I came in this morning, the dollar strength from yesterday has carried over and there’s not much to report. The pound sterling (GBP) has taken the biggest hit as factory orders fell to a 6-month low in October due to a slowing of exports, but other than that, most are wearing the same clothes from yesterday. We also have the euro trying to hang onto the 1.39 handle, which has risen slightly to 1.3925 since I first turned the screen on this morning.

To recap…Foreign investment in US Treasuries rise, which finances our debt. US industrial output slowed in September and Capacity Utilization dropped a bit, neither of which are supportive of growth, as inventory building slowed. The dollar appreciated yesterday on speculation of the Fed’s QE plans and Brazil is trying another tactic to deter traders from buying the currency. We have housing numbers here in the US and a rate decision from the Bank of Canada.

Mike Meyer
for The Daily Reckoning