Fed Meeting Spillover Aids US Dollar Strength
Good day and welcome to another Thursday. We saw another summer-like day here in the Midwest that lends itself to throwing the winter coat toward the back of the closet and forgetting about it until next winter. While it’s still way too early to take such drastic action, investors have seemingly thrown the debt problems and other fundamental concerns about the U.S. economy to the back of the closet, hidden under that shirt you got as a birthday gift years ago that was never returned.
Saying goodbye to my winter attire isn’t the wisest decision, but it’s definitely tempting. It appears the markets were looking for any type of excuse to jump on the U.S. bandwagon and see how far it would take them. We didn’t see any remnants of the choppy trading pattern from Tuesday, so it was an all-out rout by the dollar from the time we fired up the currency screens in the morning until we left for the evening. Did we have any reports that would have sent the dollar into orbit yesterday? No, not really. The party that began yesterday after the Fed meeting was still going full force and was still celebrating their upbeat outlook.
I’m always up for a good party, but when you see that guy who overindulged on punch running around with a lampshade on his head, you know it won’t be long before things start to wind down. When that guy comes out of the woodwork is anyone’s guess, but it’s usually just a matter of time. I think the same can be said with this dollar strength. The markets have such a short-term memory these days that going from one extreme to the other isn’t outside the norm, and investors have no problem bailing midstream. It’s just something to keep in the back or your mind while dealing with this market volatility.
We saw only a handful of economic reports yesterday, which included weekly mortgage applications, the import price index and the fourth-quarter current account balance. The mortgage app figures are considered secondary and very volatile, but nonetheless, they did fall 2.4%. I don’t know if you’ve paid much attention to the bond yields, but they have really shot up recently, so that doesn’t spell good news for those looking to refinance or buy a home. Bond yields have been all over the place as well, with the 10-year sitting on a four-month high, but it wouldn’t surprise me to see them turn on a dime. I’m sure the Fed isn’t exactly thrilled to see them jump over 27% since the end of January.
Finally, we had the fourth-quarter current account deficit grow to $124.1 billion, which marked the biggest shortfall in three years. The balance for 2011 widened to $473.4 billion, or 3.1% of GDP, and came in much higher than the estimated $115 billion figure. If we do see the type of increased expansion that investors have been hanging their hats on over the past few days, then I would expect to see this number continue to rise.
We have a full day in the data department today, as there are a couple of regional manufacturing reports, wholesale inflation and the TIC (Treasury international capital) flows from January. I don’t think the market will pay much attention to those, but the only wild card that I can see would be the weekly jobs numbers. If we see a better-than-expected result, investors may feel vindicated on their rosier outlook and continue to party on with the dollar. I haven’t seen much that would indicate a sharp rise, but if the report disappoints, we could see things settle down a bit.
Speaking of jobs, Chuck sent this tidbit while he was sitting in the airport yesterday morning:
“I saw this in today’s post. Talk about the book-cookers coming clean! The BLS originally said that St Louis had created 2,500 jobs in 2011. And the civic leaders were gushing, slapping each other on the back for the ‘job well done.’
“Well, a funny thing happened on the way to the forum. The BLS now has revised the numbers to show that St. Louis actually lost 3,900 jobs instead! OK, I’ve heard of revisions, but by this wide of a percentage margin? Oh, and this was reported on the back pages of the paper, hidden away in a corner hoping that no one would see it!
“But I did!”
Thanks again for the info, Chuck. Seeing a report like that is so frustrating. Investors use this type of information to make important decisions not only in real time, but also in regard to the future, so it’s no wonder we see market volatility on the rise.
Anyway, let’s move on the currency market before my blood pressure begins to rise. While the dollar rose against every single major currency, except for the Indian rupee (INR), a good portion of them took a sizable fall. The worst of the worst, which included both the Norwegian krone (NOK) and South African rand (ZAR), got caught with a stiff right jab as they were sitting on 2%-plus losses for most of the day. The general optimism surrounding the U.S. economy set the wheels in motion, but economic reports released in each country sent them over the edge and battling for last place throughout the day.
Beginning with South Africa, retail sales growth rose at the slowest pace in six months, as it fell to 3.9% in January, from the previous reading of 8.7%. The rise in January inflation to a two-year high was blamed for a majority of the slowdown as rising food, fuel and utility prices kept a lid on consumer spending. This goes along with what I was talking about yesterday regarding fuel prices in the U.S. potentially impacting future retail sales figures if consumers are forced to pay more at the pump.
The domestic retail industry has played a major role in the economy over the past year, so its much-larger-than expected fall led some investors to believe a rate cut might be needed at some point. Interest rates have remained near record lows since November 2010, when they were cut to the current 5.5%, but any rate cuts would send investors packing, as the interest rate differential has been the primary motivation to own rand. The $40 drop in gold prices didn’t help either, but there was also speculation the South African central bank has been in the market buying dollars at an increased rate.
The Norwegian krone fell to a five-week low against the dollar, and fell by the most in six months against the euro, as Norges Bank, their central bank, unexpectedly cut interest rates by 0.25%, to 1.5%. The krone was already in the hole to start the day as economists were just expecting to see a downward revision to their rate forecast, but the decision to actually move took many by surprise. The currency fell nearly 1.5% in a couple of hours and ended the day with over a 2% loss. Coupled with the 0.5% cut in December and continued government concern over a strong currency, the market took this cut to heart.
Policymakers are in a tough spot. The higher krone has been spurred by the economy’s relatively solid fundamentals. If it wasn’t an escape from the eurozone to a neighboring AAA-rated country, it was economic resilience underpinned by the oil industry attracting investors from all over the world. We have recently seen improvement in both manufacturing and consumer confidence reports, so it’s not like a poorly performing economy justified the cut. In fact, the already low internal interest rate environment has given rise to the housing and domestic credit markets, so this move will just feed the fire.
The Norwegian government has long been critical of its disproportionate currency appreciation compared with the euro, as most of their trade is with the eurozone. The stronger krone has kept inflation in the background, so the central bank would rather give manufacturers some breathing room by cutting rates and lessening the appeal to investors seeking yield than worry about the impact of easy money. It’s a delicate balancing act, as the krone was trading at a nine-year high versus the euro, but I have confidence policymakers have the ability to remain on the tightrope without falling.
It wasn’t a pretty picture on the currency screens as I was on my way home last night. The only currency that went against the grain, interestingly enough, was the Indian rupee. From what I could find, it looked as though investors were pleased with the lower-than-expected report of manufacturing inflation. This report fueled speculation the central bank would have some scope to cut interest rates in order to help bolster economic growth. Also, real returns for foreign investors were being eaten up by the higher inflation, so thoughts of higher capital inflows were on the table. The reasons for rate cuts were, obviously, different, but the market reaction to the cut in Norway certainly wasn’t positive.
Both gold and silver took another hit as speculation for QE3 hopped in the back seat after the Fed meeting. Gold fell another 1.5%, to $1,645, and silver was trying to hold onto the $32 handle when all was said and done. Even though both metals have seen a reduction in buying, silver is still up 15% so far this year and gold has seen a rise of about 5%. If the Fed doesn’t end up taking additional measures, the damage has already been done as far as the previous influx of capital into the market in the form of QE1 and QE2.
The same rationale was being applied to the market perceptions of most currencies in that if the Fed doesn’t pump more dollars into circulation, then a systemic reason for a weak dollar has been removed. I think most rational investors can look past this as being a motivation for buying the dollar. The fundamentals that have applied constant pressure on the dollar over the past several years are still present, if not worse, so looking long term paints a different picture than what has been portrayed this week.
As I came in this morning, the dollar buying frenzy has finally subsided, as the only currency in negative territory is the pound sterling (GBP). The currency is sitting on only a fractional loss at the moment, but Fitch Ratings was at it again by changing Britain’s outlook to negative from stable and threatening its AAA status. They went on to say the decision reflects the very limited fiscal space to absorb further economic shocks in light of such elevated debt levels and a potentially weaker than currently forecast economic recovery.
Then, Goldman Sachs shares plummeted 3.4% on Wednesday, cutting its market value by $2.15 billion, after The New York Times published an article by a Goldman executive criticizing the firm’s treatment of its clients and a “decline in the firm’s moral fiber.” London-based executive Greg Smith said he was resigning after 12 years with the firm.
To recap… It was another day in the sun for the US dollar as a spillover effect from Tuesday’s Fed meeting was in full force. The question then becomes how long with this last. There wasn’t much data yesterday, of which the current account deficit widened, but we’ll see our fair share today. The South African rand and Norwegian krone both fell by over 2%, but all of the currencies ended the day in negative territory except for the rupee. Diminished thoughts of QE3 spurred a selloff in metals as well.