Investor Concern Causes a Move Back to Dollars

The dollar moved higher throughout the trading day, and the rally continued in overnight trading. Just about all of the major currencies were down, with the Singapore dollar (SGD) and Japanese yen (JPY) the only two that saw a positive return versus the greenback. This would indicate that Wednesday was a ‘risk off’ day, as investors moved money out of higher yielding currencies and back to the carry trade funding favorites of the yen and US dollar.

So what caused all of the concern? Data releases in both the US and Europe are to blame. First the US… A report yesterday showed that consumer credit in the US declined in February more than anticipated. Hooray for the US consumers!! I was pretty hard on US consumers after reports last month showed an increase in spending without any increase in incomes, but I may have been too quick to criticize them. The report yesterday showed consumer borrowing fell $11.5 billion in February, which is the largest decrease in three months. The decline in credit card debt and non-revolving loans was the 12th drop in 13 months and indicates that consumers are returning to their ‘borrow and spend’ ways.

While this is an encouraging sign for the long-term health of our economy, those with shorter-term views (stock jockeys, politicians, and those in the media) were upset to see consumers lightening their debt load. US stocks sold off, and economists predicted a slower recovery for the US economy. Those with a shorter-term view would love to see another credit fueled recovery in the US, but with the uncertain job prospects many consumers are continuing to deleverage.

Fed Chairman Ben Bernanke helped increase investors’ concerns over the US recovery. “We are far from being out of the woods,” Bernanke said in a speech in Dallas yesterday. While the financial crisis has abated and economic growth will probably reduce unemployment over the next year, the US faces hurdles including the lack of a sustained rebound in housing, a ‘troubled’ commercial real estate market and ‘very weak’ hiring, he said.

And data released yesterday in Europe did nothing to brighten the mood for investors. As I reported in yesterday’s Pfennig, Europe’s economy unexpectedly stalled during the fourth quarter with GDP remaining unchanged after growing 0.4% in the previous quarter. A report this morning showed European retail sales declined the most in nine months in February. Sales in the euro region fell 0.6% during February, the largest drop since May of 2009. Euro-area companies will need to rely on exports to boost sales, and the recent sell-off in the euro (EUR) should help. German Chancellor Angela Merkel knows her export driven economy benefits from having a weaker euro, and I still believe her moves last month regarding the Greek crisis were partially motivated by a desire to see the euro weakened. With a weaker euro, exports from the euro area should increase in the coming months, and the euro economy will be better for it.

While the euro seems to have found a bottom recently, many are still predicting a further drop. I read a UBS published technical report yesterday which predicts the euro will fall to $1.2892 or even lower in the near term. “As long as a recent resistance level of $1.3490 holds, the technical odds point toward a sharp decline in the near run,” the UBS report stated. The drop would be precipitated by a fall below the 10 month low of $1.3280 which the euro reached on March 25th. Again, we aren’t technical traders here on the desk, but I do like to read what the techies are looking at as it gives me some levels to watch out for.

In other European news, the pound sterling (GBP) dropped versus the US dollar after a report showed weaker than forecast growth for UK service companies. The services gauge slipped to 56.5 in March from 58.4 in the prior month. Economists were predicting a level of 58, and investors looked at the number as a further indication that there is just too much optimism about the UK economy. But other reports showed that housing prices rose more than forecast and manufacturing production expanded more than twice what economists had predicted. So the data really didn’t give investors a clear picture of the future of the economy. Investors don’t like inconsistent data, and the upcoming UK elections only added to investors’ unease.

Polls showed the opposition Conservatives’ lead over Prime Minister Gordon Brown’s Labour Party has narrowed, increasing the chance that no party will win a majority in next month’s elections. The Conservatives’ lead has slipped to just 5 percentage points, down from 10 points a few days ago. We will see a lot of volatility in the pound sterling during the run up to the elections, which will be held on May 6th. Right now it is looking like neither party will have a clear majority leaving a ‘hung’ parliament. If there is no clear winner, it will make cutting Britain’s record budget deficit very difficult. The Conservatives plan immediate cuts, while Prime Minister Gordon Brown says curbing spending too quickly risks a ‘double-dip’ recession. As I stated earlier, investors hate uncertainty, and I would think we would see a further weakening of the pound as the polls swing back and forth.

The Canadian dollar (CAD), which has been one of the bright spots of the currency markets over the past month, could not hold on to the $1 level and slipped lower yesterday. But the drop really doesn’t worry me, as it looks like a natural pull back after the loonie pushed through the $1 level in both of the past two days. Canada’s economy expanded 0.6% in January, the fastest pace in three years, adding to evidence that the country is recovering more quickly than policy makers and economists expected.

The Brazilian real (BRL) slid a bit as investors worried the central bank would step up dollar purchases to slow the appreciation of the currency. The markets look at the 1.75 level as a line in the sand for the Brazilian central bank. The central bank has stated a desire to limit the appreciation of the real, and the markets look for them to intervene any time the real nears the 1.75 level. With a history of intervention, the markets will continue to be cautious around the 1.75 level and the currency will have trouble increasing through this level.

We have a pretty active mortgage desk down at our Jacksonville headquarters, and Andrew Murray writes a daily piece that is distributed to all of our mortgage brokers with rate updates. He also adds a paragraph or two of his own commentary on the markets. Yesterday he ended his daily missive with the following paragraph, which I thought was dead on:

“With some irony I noted that…Greenspan, whose permissive rates and lax capital requirements, appeared before the Financial Crisis Inquiry Commission and recommended higher capital and collateral requirements. To his credit, in the recent past he did admit that he was wrong. Must have been a tough pill to swallow. Imagine, you retire, write a book about how great you were, go on CNBC and chill out with Maria Bartiromo and then… WHAM! The economic system that you left as the MVP of all Fed Chairmen bites the dust like never before. But before his testimony was over he also added this little nugget. ‘Taxpayers will not be at risk. Financial institutions will no longer be capable of privatizing profit and socializing losses.’ I’m feeling irrationally exuberant already, how about you?”

Thanks to Andrew for allowing me to share this with you. Greenspan’s face was all over the cable news shows yesterday, as he is doing another promotional book tour. Amazingly, the guy who couldn’t see the bubbles being created here in the US is now seeing bubbles in a number of global economies. Asked in a Bloomberg TV interview about a possible bubble in China, Greenspan (or Dr. Greenspan as he likes to be called now) said there were ‘significant bubbles in Shanghai and along the coastal provinces’ and ‘some of that in the hinterlands’. As Caroline Baum points out in a Bloomberg article, Greenspan’s delusions are getting much worse with age!

Jim Rogers is also worried about asset bubbles in China, but thinks the Chinese will allow a one-time appreciation of the Chinese currency in order to combat these bubbles. “China knows that they cannot have a major world economy with a blocked currency,” Rogers said in an interview on Bloomberg. “Whether the renminbi is overvalued or undervalued against the dollar, I hope the market will let us know. I hope the Chinese will let it float.”

Rogers also said the economies of both China and India will continue to grow, leading to further support of the commodity markets. The bull run in commodity markets will continue as the world faces supply constraints and investors shouldn’t sell gold now as the precious metal could rise to “at least $2,000 by the end of the decade,” Rogers said. Rogers also said he likes the Canadian and Australian dollars (AUD) and sees ‘enormous value’ in the Brazilian real. You can see why Rogers is one of the favorites of the desk. He is singing from the same sheet of music as us.

Rogers is a resident of Singapore, a country that will seek a strengthening of their currency. A recent survey of economists predicted the central bank of Singapore will favor a stronger currency by October to curb inflation and catch up with regional peers. The central bank uses the exchange rate, rather than interest rates, to conduct monetary policy. The currency has risen just 0.4% this year, lagging behind several of its trading partners, and many believe the central bank will play a little ‘catch up’ in the coming months.

Chris Gaffney
for The Daily Reckoning

The Daily Reckoning