Stocks Push the Currencies Higher
The dollar has rallied just a bit overnight, clawing back some of the losses that occurred mid-morning yesterday.
And what, you might asked, caused the dollar to rally yesterday? You can re-read a bit of yesterday’s Pfennig for the answer: “The data cupboard has been emptied out and is looking to get restocked today… So the only thing besides sentiment moving the markets today will be the direction of stocks…” Yes, Chuck was right in predicting what would drive the currency markets yesterday, as the dollar got sold off as stocks moved higher.
Without any data to push the markets one way or another, investors began moving back into riskier assets, selling their ‘safe haven’ US treasury holdings. The currency markets have been trading on the risk theme lately, and don’t seem ready to break this pattern anytime soon. Risk appetite is the main driver of the currency markets, with the dollar gaining with investor worries, and falling back down as investors feel more confident.
I spoke at an investment conference last week in Chicago, and listened to several good presentations on the current state of the economy. While every speaker had differing opinions on how to invest during the next few months, they all seemed to agree on one thing: the recent rally and ‘recovery’ would reverse, and the US will likely head back into another downturn. The timing of this next downturn is hard to pin down, but most believe we will see the US economy falter again toward the first quarter of 2010. If and when this occurs, the dollar could see a temporary rally as investors flee back into US treasuries. But longer term, everyone at the conference was in agreement with what Warren Buffet said in his op-ed piece yesterday: the US dollar will ultimately lose value.
Speaking of Buffet, I re-read his op-ed last night during dinner, and had to laugh a bit, as much of what he wrote could have been taken directly from the presentation I gave last week. The following lines were especially poignant, so I decided to include them in the Pfennig:
“An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually – and in combination.
“The current account deficit – dollars that we force-feed to the rest of the world and that must then be invested – will be $400 billion or so this year. Assume, in a relatively benign scenario, that all of this is directed by the recipients – China leads the list – to purchases of United States debt. Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased.
“Then take the second element of the scenario – borrowing from our own citizens. Assume that Americans save $500 billion, far above what they’ve saved recently but perhaps consistent with the changing national mood. Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).
“Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington’s printing presses will need to work overtime.
“Slowing them down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.”
This is what we have been preaching over the past several years, that the deficits, if unchecked, will ultimately lead the government to put the printing presses in overdrive, and we will attempt to inflate our way out of debt. This will cause the value of the US dollar to drop. Buffet ended his piece with the following line: “Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress.”
Sorry to spend so much time on Warren Buffet, I know he isn’t the most popular guy with many Pfennig readers. But you can’t deny that he has been an extremely successful investor, and the piece he wrote for the NY Times was just right on in my opinion.
Lets get back to the currency markets. Good news helped propel the Norwegian krone (NOK) higher overnight. Norway’s economy grew last quarter, pushing the world’s fifth largest oil exporter out of recession. Norway’s mainland economy (ex oil and gas) was able to grow 0.3% during the second quarter. Economists had predicted that Norway’s economy would contract by the same margin. The overall economy still contracted, as oil revenues declined, but the recent move higher in crude should help keep Norway on the growth path in the second half of 2009. Petroleum exports make up a quarter of Norway’s output, so a global recovery is definitely good news for Norway. This currency, which was called the safest in the world by the NY Times, should be part of every investor’s portfolio.
The UK economy is doing quite as well as Norway’s, as Britain reported a record $13.2 billion budget deficit in July. This is the largest deficit reported for July since records began. Quarterly tax payments usually boost the revenues in July, but the recession has taken its toll on tax revenue, and unemployment benefits are pushing outlays higher. The UK is predicted to have the biggest deficit in the G20 next year according to the IMF. The pound sterling (GBP) was the largest loser versus the US dollar on the back of this reported deficit.
Minutes of the BOE’s August 6 meeting were released yesterday, and it showed that BOE Governor Mervyn King pushed for an even looser monetary policy. King pushed to expand the ‘quantitative easing’ that the BOE began in March. The pound lost more ground after the release of the report, as investors lost faith in King as an inflation fighter.
Chuck sent me this note last night and wanted me to include it in today’s Pfennig:
“I forgot all about the fact that this is that time of year again when central bankers and economists from around the world have a boondoggle at Jackson Hole Wyoming… You might recall that last year they all hunkered down and tried to think of ways to keep the financial mess from worsening, only to have Lehman Brothers collapse a few weeks later!
“Well… I’m sure we’re going to hear a lot of rhetoric about the ‘recession coming to an end’… But they have it all wrong! This isn’t a recession it’s a depression…
“With pockets of risk remaining, such as the collapsing US commercial real estate market, and the double digit unemployment rate… I would think that these guys who missed seeing the subprime meltdown coming and then when it was presented to them, told us it wouldn’t filter out into the economy… Should just keep their opinions to themselves and read newsletters like The Daily Pfennig and The Currency Capitalist, and The Daily Reckoning, and The 5-minute Forecast… OK I’ve had my say, thank you for letting me vent! Have a nice day!”
Yes, the ‘top’ economic minds (minus Chuck) will be meeting in Jackson Hole, and Ben Bernanke will undoubtedly trumpet the fact that data shows the US economy is starting to pull out of its recession. This morning we will get the index of US leading economic indicators which is projected to show a move up in July; the fourth consecutive positive monthly move. The weekly jobless claims are also expected to be a bit positive, with a fall to 550K from last week’s 558K. But the jobless rate is still projected to reach double digits (the real number has been in double digits for a while!) and housing will continue to be a drag on the economy.
The administration will also announce that the US deficit for 2009 will be slightly less than what was forecast in May. Yes, our government’s deficit will total just $1.58 trillion… About $262 billion less than the previous estimate. But the change isn’t due to increased revenue; it is mainly due to the administration’s scrapping of a $250 billion contingency plan to aid the financial industry. With the recent signs that the economy is starting to pull out of recession, the Obama administration decided it no longer needed to hold the quarter trillion dollars in reserve to meet predicted bank failures. But I would still be a bit worried if I were the administration, as there will likely be a few more ‘big’ bank failures down the road. Personal bankruptcies continue to climb, and as Chuck pointed out above, the commercial real estate market still has a few ‘surprises’ in store for the economy.
Even after this adjustment, the deficit figure would amount to 11.2% of the GDP, the largest share since 1945 when we were paying for WWII. And unfortunately, with growing outlays for Social Security, and interest on the debt eating up a larger overall percentage, the deficits won’t be shrinking in the near future.
A jump in oil prices and a reversal of risk aversion caused the South African rand (ZAR), Mexican peso (MXN), and Australian dollar (AUD) to rally. South Africa led all currencies versus the US dollar overnight, with a 0.54% appreciation. Mexico’s peso rose for a second day as oil moved back above $72 per barrel. Oil revenue funded 38% of the Mexican government’s budget last year, so the peso is somewhat linked to the price of crude. The jump in oil also helped the Canadian dollar (CAD) reverse earlier losses.
The Australian dollar rallied as risk investors moved back into higher yielding currencies, and good news in the Asian stock markets continued the rally. The Aussie dollar also benefited from the rally in oil, Australia’s fourth most valuable raw material export. The Aussie dollar is one of the best performers over the past three months, with only the New Zealand dollar (NZD) and Brazilian real (BRL) outperforming it versus the US dollar.