Economic Releases Drive Currency Markets

The currency markets were a bit more volatile yesterday, as we got some surprising data releases here in the US… But after the dust settled, the dollar closed out the day pretty much right where it had started versus most of the major currencies. Gold and silver continued to slide, but the price of oil moved up a bit. Today we will get another big round of economic data, which could cause some more volatility in the markets.

The driver of the currency markets yesterday were the economic releases here in the US. The morning started off with the Commerce Department’s final reading of GDP for the third quarter of 2009. The final figure showed an increase of just 2.2% for the third quarter, well below the consensus estimate of 2.8%. The report illustrates just how optimistic (and some feel unreasonably so) the folks at the Commerce Department are. Their first estimate of third quarter GDP was 3.5%, but after further evaluation they lowered that figure to 2.8% for their second estimate. And after a further review of the data, they settled on the 2.2% figure, a full 1.3% lower than their original estimate. This is a downward adjustment of close to 40%! I’m sure there wasn’t any pressure on the Commerce Dept. to inflate the first couple of estimates.

And even the 2.2% isn’t a sustainable figure. Much of the growth that occurred in the third quarter was due to the cash for clunkers program and the housing incentives. So government stimulus accomplished what it was supposed to do and pushed GDP up a couple of percentage points. But what happens when the stimulus programs end? Is the economic recovery strong enough to last without the huge government cash infusions? And how are we going to pay for all of these stimulus programs?

A chart in this week’s Economist magazine does a great job pointing out the legacy of the financial crisis. The accompanying paragraph explains that the developed countries of the G20 have aggressively stimulated demand by loading up on debt. Even with these aggressive stimulus programs, the advanced economies are forecast to experience weak GDP growth next year. In contrast, G20’s developing countries were less aggressive with their stimulus, but are still on track for strong growth. The IMF forecasts that gross government debt among advanced economies will continue to rise until 2014, reaching 114% of GDP, compared to just 35% for developing nations. Rich countries have put themselves in a much riskier position going forward, with lower expected growth and higher debt levels than the less advanced developing nations.

The lower GDP number caused a sharp drop in the value of the dollar, but the sell off only lasted an hour and a half. This is when the National Association of Realtors released their existing home sales figures. According to the report, purchases increased 7.4%, easily exceeding the highest estimates. This surprisingly strong number made investors forget the lower GDP and stocks and the dollar rallied.

Today we will get a look at consumer spending and New Home sales. If it is anything like yesterday, the first set of numbers will show that consumers have slowed their purchases, which would drop the dollar’s value. But then New Home sales would come in higher, rallying the dollar back up. We will also see U. of Michigan consumer confidence, which is predicted to rise.

French consumer spending unexpectedly fell in November as employment concerns trumped France’s version of cash for clunkers. The drop put pressure on the euro (EUR) which was already sliding versus the US dollar on sovereign credit concerns. In an interview on Bloomberg, Goldman Sachs Chief Global Economist Jim O’Neill warned that the euro’s stability could be jeopardized if the budget concerns in Greece spread to larger economies such as Spain. “If you start having serious problems credit wise with the likes of Spain, then the issue for the euro’s credibility and its pricing against other currencies becomes a much bigger issue,” O’Neill said. But he went on to say that much of this is already priced into the euro, so unless we see additional downgrades, the euro should hold its value.

The pound sterling (GBP) sold off and traded within half a cent of its lowest level in two months after the BOE’s meeting showed that policymakers were unanimous in backing a continuation of quantitative easing. Some members questioned the effectiveness of the QE programs in getting funds into the real economy. The program, which is pumping money into banks through the purchase of bonds, hasn’t increased the money supply as banks have simply sat on the additional liquidity. The Fed has copied the UK’s quantitative easing program here in the US, where its impact is also being questioned. The program of monetizing the debt is risky, as it is seen as one of the most inflationary actions a central bank can undertake. But inflation is currently being held in check; the big question is just how long inflation will stay hidden.

With the dollar moving higher, the price of gold has been falling. The shiny metal has given back almost all of the gains it booked during November, and continues to trade below $1,100. With growth returning to the economies across Asia, commodity prices should rebound. Also, the QE programs and loose credit policies will ultimately lead to inflation which will be another item supporting higher gold prices. I have to believe that in a few years time, the current prices of gold will be seen as good entry levels.

The Daily Reckoning