Dollar Rally Peters Out
Most currencies started Wednesday in the loss column versus the US dollar, but rallied as the day progressed. The dollar had strengthened over the past couple of days due to ‘safe haven’ demand; but a surprisingly strong durable goods number (ex autos) combined with an ‘all clear’ signal from President Barack Obama had investors moving back into riskier assets. The commodity based currencies also got a boost as China signaled it would maintain an accommodative policy, easing speculation that the Bank of China would try to rein in bank lending. Lots to cover today, so lets get right to it.
Durable goods orders for June were released yesterday morning, and the overall number actually showed a pretty dramatic drop of 2.5% compared to the month prior. But the overall number includes automobiles, and with many of the big 3 automobile plants shut down for part of June, the markets were focused on the number ex transportation. Orders for durable goods, excluding automobiles and aircraft unexpectedly rose 1.1% in June following an adjusted 0.8% rise in May. The ex auto number was strong enough for some to reason that companies would have to start boosting output in the coming months. While the 1.1% jump in orders is nice to see, the overall drop was pretty dramatic, and the auto sector makes up a large percentage of overall output for the US.
Just after noon the Fed’s Beige book survey of economic conditions was released. The report said the pace of the US economic recession slowed or stabilized in most areas of the country and pointed to a protracted period of weakness as the economy transitions to recovery. The Fed said labor markets across the country were ‘extremely soft’ and wages and compensation were steady or falling in most areas. Not the rosiest of pictures for the economy, but not overly negative either.
The nation’s #1 cheerleader was out in full force yesterday afternoon, as President Barack Obama defended his administrations policies during a speech in North Carolina. President Obama’s poll ratings have slipped as unemployment continues to be a drag on consumer confidence. So he took a break from pushing his health care reform to defend his economic policies, saying he had helped avert an economic disaster as the US economy was in a “freefall”. He stated that the US “may be seeing the beginning of the end of the recession”, and that his stimulus plans had “helped stop a recession from becoming a depression”.
The British pound (GBP) was one of the biggest gainers versus the US dollar yesterday, after a report showed that UK house prices rose in July for a third consecutive month. Another report showed that the average cost of a home in the UK rose 1.3%. The pound will probably end up in positive territory versus the US dollar this month for a fifth consecutive monthly gain. The rally is a relief for pound sterling investors as the currency dropped more than 26% versus the US dollar last year. A Standard Chartered PLC analyst predicted further strengthening for the pound sterling in a report released yesterday. The analyst stated that the US dollar is in a multi-year downtrend, and the pound will likely push up to $1.75 by year-end.
But there is still the question of deficits in the UK. The BOE was one of the first central banks to institute ‘quantitative easing’ policies, and many are looking for them to be the first to stop the program. With the UK housing sector stabilizing, officials will likely pause the asset-purchase program which was set up to lower borrowing costs. But the UK is still going to have to deal with a record deficit, similar to the problems facing the US. The UK Treasury said it would sell a record 220 billion pounds of debt in the year ending March 2010 to offset falling tax revenues and increased government spending. Again, good news for the pound in the short term, but the storm clouds are still gathering.
Positive news out of Europe this morning has helped keep the euro (EUR) moving up in early trading. European confidence in the economic outlook increased more than economists forecast in July, as an index of executive and consumer sentiment climbed to the highest reading since November. But the economic recovery in Europe is still very fragile, as evidenced by another report which showed retail sales fell for a 14th month in July. Unemployment in the euro region continues to be a concern, with the unemployment rate expected to reach 12% in 2010.
Both Morgan Stanley and BOA/Merrill Lynch told investors to sell the dollar versus the euro in research reports released yesterday. Morgan Stanley said investors should sell the dollar against the euro, Norwegian krone (NOK), and Canadian dollar (CAD) as the global outlook improves. “As the outlook continues to improve, we believe that currencies with strongest ties to the global growth cycle will outperform at the expense of the US dollar,” a currency strategist at Morgan Stanley wrote in a note to clients. BOA raised its forecasts for the euro predicting it would rise to $1.50 by year-end. The report highlighted the diversification of reserves as a key driver of the euro. The euro is predicted to continue to gain versus the US dollar as central banks diversify reserves into euros from US dollars as the US government is debasing its currency through its program of printing money to buy assets such as Treasuries.
One currency that hasn’t been performing well versus the US dollar recently is the Swiss franc (CHF) which is one of the few currencies to drop versus the US dollar over the past month. This is exactly what the Swiss National Bank has been trying to accomplish, as they have spent as much as $32 billion since March to keep the Swiss franc from appreciating. The SNB sold the franc and cut interest rates on March 12 to stem the currency’s gains. The Swiss continues to be a popular choice for investors, but problems with Swiss banking and the government intervention will likely keep the Swiss franc from rallying dramatically. However, as Chuck has pointed out several times in the past, no central bank (not even the Swiss) has enough money to fight the currency markets. The markets will eventually win out, and the longer-term prospect for the Swiss franc is still positive. It is just that we feel there are other currencies that have better prospects in the near term.
Norway is one such currency. Norway’s central bank will likely be one of the first among the world’s richest economies to begin raising rates as the global crisis shows signs of abating. Inflation in Norway is likely to increase past the Norges Bank’s target, increasing pressure for Norway’s central bank to hike rates. The markets are beginning to price in an increase in rates at the beginning of next year as the Norwegian economy starts to heat up. Oil revenues, and a conservative fiscal policy helped to soften the impact of the global economic crisis, and Norway is now set to be one of first European economies to recover. Retail sales in Norway were up 2.6% in May since March and underlying inflation accelerated to an annual 3.3% in June, the fastest pace in eight months. The housing market in Norway is also pushing the recovery, as property values rose 5.3% in the three months ended June, the second quarterly gain.
Norway’s neighbor, Sweden, is another currency that has been performing quite well versus the US dollar. The Swedish krona is second only to the Australian dollar (AUD) in return versus the US dollar over the past week, and is among the top three currencies this month. Sweden’s krona is benefitting from a jump in exports as Sweden’s trade surplus almost doubled in June as exports to Europe and the US increased. The Swedish krona has also benefitted from recent IMF support of the Baltic region, where Swedish banks are heavily exposed.
The Australian dollar continued to climb overnight, and is the best performing currency versus the US dollar in the past week. Investors are betting that the Reserve Bank of Australia will be one of the first central banks to start raising rates. With the US Fed keeping interest rates near zero, investors are likely to search for yield, and interest rate differentials will push the Aussie dollar higher. We saw a similar pattern back in 2003, when the Aussie dollar rallied over 30% versus the US dollar on interest rate differentials. Australia’s economy unexpectedly grew in the first quarter, and recent rhetoric from RBA Governor Stevens suggests the start of a tightening cycle sooner rather than later.
Brazil’s real (BRL) continues to be a strong performer and is expected to strengthen to 1.8 per dollar by year-end according to JPMorgan Chase & Co. The real will strengthen due to faster economic growth and higher demand for commodities according to JPMorgan. The currency will benefit from a stronger trade surplus and increased foreign investment. In news released yesterday, China Development Bank Corp, the state run bank for public works projects, stated they plan on opening an office in Rio de Janeiro next year, one of its first branches outside mainland China. Close ties with China will continue to benefit Brazilian exports of commodities. The Brazilian economy will expand at an annualized pace of 4.2% in the second, third, and fourth quarters this year according to research by JPMorgan.