Central Banks Pump Dollar Liquidity into the Markets

The dollar continued on its decline through most of the trading day yesterday, but fell off a cliff in very early European trading. A coordinated central bank action to lower swap rates was the reason for the dramatic moves in the currencies this morning. The FED, ECB, BOJ, SNB, BOC, and BOE all agreed to cut the cost of providing dollar funding via swap arrangements. They also agreed to make other currencies available as needed, but the primary function of these swap arrangements was to push more dollar liquidity into the markets. Swap agreements give the banks US dollars today for euros or other currency payments at some future date. It effectively pumps fresh US dollars into the markets which will be pulled back out at some point in the future. The move was seen as necessary in order to prop up the European banks which have been hard hit by the euro financial crisis. The additional liquidity was welcomed by the markets, with the European stock markets and early US markets up nicely.

China also got into the global financial game by cutting the reserve requirement ratio for banks by 0.5 percentage points. This is another move to help pump more money into the global financial system. The Chinese are sitting on a mountain of US dollars, and the lower reserve requirements will enable them to push some of these dollars back into the markets. The Europeans hope China will be buying sovereign debt with some of the newly released reserves. And officials in China have certainly made it known that they will be willing to help support the EU. This is just another opportunity for China to take on more of a leadership role in global financing.

Since the US dollar is the reserve currency of the world, a majority of this new liquidity is in the form of US dollars. The old supply and demand curve is at work this morning, and the central banks just pumped a bunch of supply into the markets, so the value of the US dollar has fallen fairly dramatically. The dollar is down about 2.5% across the board, with the commodity currencies leading the way for a third consecutive day. The Aussie dollar (AUD) was up almost 3%, Brazilian real (BRL) up over 2.5%, New Zealand dollar (NZD) and South African rand (ZAR) up 2.25% versus the US dollar. The concerted effort by the top 7 central banks definitely has global investors feeling better about their ability to avoid another financial meltdown in Europe.

The stock markets needed a boost, as the US markets were going to book over a 4.5% loss for the month of November. S&P cut debt ratings of some major banks yesterday, including the Bank of America, Goldman Sachs (not actually a bank but they sure act like one), and UBS AG. Sounds like some of the folks over at S&P were reading the same Bloomberg story that I shared with all of you yesterday. Data released in the US yesterday showed that home prices were down even more than expected, dropping 3.59% YOY in September. This morning we have the Challenger Job Cuts which posted a 12.8% drop in November, and the ADP employment change which came in much better than expected. Both of these numbers are positive signs for the labor picture here in the US, and give even more courage to investors who last week were worried about the global recovery.

Mike Meyer is helping me get this out today, and sent me the following to share with readers:

The easing in China provided a much needed boost to the high yielding/commodity based currencies. The reduction in the reserve requirement ratio is more of an insurance policy against any type of European debt escalation instead of a direct response to slowness in the Chinese economy. In other words, they are trying to be proactive as opposed to reactive if the global economy does take a turn for the worse.

The big winner of the day so far has been the Australian dollar by gaining close to 3% against the dollar this morning. The reduction of the bank reserve ratio in China was a big catalyst but third quarter business investment in Australia increased by the most in 15 years as the mining industry continues to expand. In fact, capital spending rose 12.3% from the second quarter as companies are boosting spending to meet continued demand from China and India.

The Bureau of Resources and Energy Economics reported that the value of minerals and energy products under development in Australia rose to a record AUD 231.8 billion as of October 31, which is up 34% from April and 74% year over year. While the capital expenditure numbers were very encouraging, policy makers are still cautious by saying they are not immune from what’s going on in the global economy, namely in Europe, suggesting they will continue to monitor the economy and make policy adjustments if necessary.

Then there was this…According to The Wall Street Journal, US exports of gasoline, diesel and other oil-based fuels are soaring, putting the nation on track to be a net exporter of petroleum products in 2011 for the first time in 62 years. A combination of booming demand from emerging markets and faltering domestic activity means the US is exporting more fuel than it imports, upending the historical norm. According to data released by the US Energy Information Administration on Tuesday, the US sent abroad 753.4 million barrels of everything from gasoline to jet fuel in the first nine months of this year, while it imported 689.4 million barrels.

To recap… Six of the largest central banks worked together to pump more US dollar liquidity into the markets, causing a dramatic drop in the US dollar. Investors are regaining confidence in the global recovery, and are moving money into higher yielding currencies.

Chris Gaffney
for The Daily Reckoning

The Daily Reckoning