U.S. Dollar Saved by Oil

Good day… And welcome to August. The markets had a little more movement yesterday as the U.S. GDP report came in lower than expected, and had a hidden surprise for dollar bears (more on that later). In addition to the poor GDP numbers, personal consumption dropped, and the GDP Price Index also showed a decrease. The employment cost index was flat, and the weekly jobless claims were slightly higher than expected at 448K. More Americans filed initial unemployment claims last week than at any time in more than five years. The only positive piece of data released in the United States yesterday was the volatile (and somewhat unreliable) Chicago Purchasing Managers number which showed an increase back above 50.

With all the bad data, the dollar sold off rather sharply and the euro (EUR) jumped a full cent to trade over 1.57 for a short while. But the dollar bears didn’t celebrate for long, as the dollar sharply reversed course as crude oil prices rode to its rescue. As I explained earlier in the week, the price of crude oil and the U.S. dollar have had a very tight relationship lately, with a correlation of 0.9. Just after the dollar fell due to the GDP releases, crude oil began a sharp $3 drop and saved the U.S. dollar from further losses. The price of oil has continued to slide, and is now down over 11% in the past month. This has helped prop the dollar up in spite of a number of poor economic reports here in the United States.

But I promised some explanation of the U.S. GDP report in the opening paragraph, so here it is. While the second quarter numbers came in slightly lower than economists had expected (1.9% versus expectations of 2.3%), a revision to the fourth quarter ’07 GDP report is what caught everyone’s attention. You see, the report revealed that the U.S. economy actually shrank in the fourth quarter of 2007. Previously, the Commerce Department had reported the U.S. GDP for fourth quarter ’07 at a 0.6% gain. Back when the number came out, the news media was using the figure as proof that we weren’t in a recession. Well now the Commerce Department has come clean and admitted the true number. The world’s largest economy contracted at a 0.2% annual pace in the fourth quarter of last year.

This number now confirms the general picture of weakness that Chuck and I have been painting. And in spite of the temporary boost from tax rebates, I think the recession that the U.S. is now in will only deepen. Revised government figures have also shown that consumer spending slowed more than previously estimated, and that the housing slump worsened during the end of 2007. Harvard University Professor Martin Feldstein agrees with the Pfennig. “The U.S. may now be in a ‘very long’ recession with little that the Federal Reserve can do to help”, said Professor Feldstein during a Bloomberg radio interview. “I don’t see recovery on the horizon.” Feldstein was a former advisor to President Reagan, and headed the National Bureau of Economic Research until June of this year, so he knows what he is talking about.

Former Fed Chief Alan Greenspan also chimed in yesterday in a CNBC interview. The Former Fed head said falling home prices are “nowhere near the bottom” and that the resulting market turmoil isn’t showing signs of abating. Greenspan sure should be an expert on the housing crisis; he helped to create it! I just wonder what the current FOMC members think when Greenspan sits back and comments on the mess he left them with. You know Bernanke would love to just give it all back to him to deal with!

With all the experts commenting on how bad the U.S. economy is – and not giving a rosy picture for the future – Treasury Secretary Hank Paulson decided it was time to try and ride to the rescue. Paulson said he expects the government’s fiscal stimulus plan will boost economic growth in the second half of the year, offsetting a housing downturn and high energy prices. What planet is this guy on?? How many times has he come out and said ‘the worst is almost over, it will be better next quarter’? Here is a quote from Paulson which I just have to share with you: “While our economy faces substantial difficulties that will continue to drag on growth in the short term, it is important to remember our long-term fundamentals are strong”. I guess Paulson wasn’t included on the memo about the record $490 billion budget shortfall, and he probably just forgot all about having to come to the rescue of Fannie and Freddie. “Strong Fundamentals”??? Paulson has ingested too much of the Kool-Aid the administration has been pushing.

Today we will get some more data in the United States reflecting the so-called ‘strong economic fundamentals’. Payrolls in the U.S. are predicted to show a seventh monthly decrease in July. With the predicted 75K loss in jobs for July, the unemployment rate is expected to rise to 5.6%. Manufacturing payrolls will again be hardest hit as they are predicted to have fallen by 40K during July. But cutbacks at UAL Corp. and Starbucks Corp. signal that firings are spreading beyond builders and manufacturers as the cost of raw materials soars. Many are expecting accelerated declines in payrolls through the end of the year, which would put additional pressure on an already overburdened U.S. consumer. These employment figures will reinforce concerns that the economy is in a recession, as the July cuts will bring the total drop in payrolls so far this year to more than half a million. But don’t worry; Secretary Paulson says the long-term fundamentals are strong!!

The negative data may force the U.S. dollar to give back some of the gains it took during the strange month of July. Now that we are in August, a step back to review July is appropriate. The greenback strengthened 1% against the euro and 1.6% versus the yen (JPY) in July, on speculation that the U.S. growth slowdown is spreading to other nations. Crude oil also helped the dollar, as a slowing U.S. economy caused fuel consumption to weaken to the lowest in three years. Oil had the biggest one-month decline since December 2004. While I agree that the world’s economy will slow in the coming months, growth will continue at a pretty good pace in Asia and the developing world, keeping demand for oil and other commodities up. While the fall in oil during July propped up the U.S. dollar, I don’t think we can count on further dramatic declines.

The worst performing currency for the month of July was the New Zealand dollar (NZD), which fell by 3.88% versus the greenback. New Zealand fell after the Reserve Bank of New Zealand lowered interest rates on July 24 and signaled they will continue cutting rates. This was the first reduction in interest rates in 5 years, and with a bias for more cuts, the currency has sold off. Many investors had moved into the kiwi chasing high yields, so the expected cuts in interest caused this ‘hot money’ to move back out. Investors in the New Zealand dollar would be advised to exit these positions as they come due.

So where should investors turn? According to the Economist’s ‘Big Mac Index’ the best values are in Asia. The Economist magazine compares prices for McDonalds Corp.’s burger globally, and is a light-hearted barometer of whether currencies are properly valued against the dollar. As of July 26, when the Economist published its 2008 index, 10 Asia-Pacific region currencies were undervalued against the U.S. dollar, many significantly so. Currencies which were below their true worth, according to the Economist, included 52.1% in Hong Kong, 48.7% in China, 26.6% in Japan, and 18.2% in Singapore. It is nice to see that the ‘Big Mac Index’ agrees with our thoughts that the Asian currencies are undervalued.

Our metals trader, Kristin Kuchem just came in. She has been on the road in Las Vegas this week, and will be out again in San Francisco next week. It is great to have her back on the desk; should help with the phone volume today. Now on to the Big Finish…

Currencies today 8/1/08… A$ .9355, kiwi .7281, C$.9756, euro 1.5566, sterling 1.9754, Swiss .9537, ISK 79.47, rand 7.3230, krone 5.1409, SEK 6.0646, forint 149.92, zloty 2.0673, koruna 15.44, yen 107.63, baht 33.55, sing 1.3696, HKD 7.8038, INR 42.41, China 6.8432, pesos 10.01, BRL 1.5654, dollar index 73.34, Oil $122.89, Silver $17.59, and Gold… $911.52

That’s it for today… I can’t believe summer is already starting to wind down. I got home last night and my daughter was decorating her new book bag, already getting excited about going back to school. My son, who is facing his first year at a pretty tough high school, is much less excited. August is probably my least favorite month here in St. Louis, as the temperatures reach well into the ’90s and humidity is always high. Makes my training for the upcoming LSL triathlon and Chicago marathon a little harder, as I’ve been having to run in the evenings instead of first thing in the morning. I guess I really shouldn’t complain though, the beauty of living here in St. Louis is that the weather is never the same for very long. Before you know it we will be complaining about the cold! Hope everyone has a Fantastic Friday, and a great weekend.

Chris Gaffney
August 1, 2008