The Two Divergent Views of Currency Market Investors

The weekly jobs numbers released yesterday morning showed 25K more people signed up for unemployment last week than the week prior. The number of continuing claims declined slightly, but remains above 4.5 million. The data confirms what everyone outside of CNBC has been saying for quite a while; this is a ‘jobless recovery’ (if you can even call it a recovery!) What growth we have had has been spurred by government spending, the private sector just isn’t expanding, and won’t probably expand for some time.

The currency markets couldn’t figure out how to react to this negative weekly jobs report, with the dollar dropping dramatically just after the release, but then shooting right back up a short while later. As I explained yesterday, currency traders seem to be ‘on the fence’ with regard to the dollar right now; but I sense a shift in the overall sentiment. The past year we have seen investors using the dollar as a ‘safe haven’ trade, running to it whenever any bad economic data was released. During times of global uncertainty, investors have traditionally believed that the US Treasuries are the best place to park short-term money. The Sovereign debt crisis in Europe focused investors’ attention on risk, and made the US Treasuries even more attractive.

During the euro-debt crisis, CNBC and all of the other cable channels directed toward the stock jockeys whipped their viewers into hysteria. They convinced the masses that the US was the only place to park your money; Europe and Asia were just too risky! I can’t tell you how many times I would see someone on the monitors up above our trade desk talking about the risks of a China asset bubble, or the how the euro (EUR) was going to be crushed by the sovereign debt crisis. These equity market cheerleaders had everyone convinced that the US was way ahead of the rest of the world on their way out of the global downturn.

But the debt crisis has calmed, and markets are starting to return to normal, giving investors an opportunity to see through the fog of hysteria. And when you look at the economic data, the rest of the world really doesn’t look that bad. Investors are now starting to realize that the US economy really isn’t that far ahead, and looks to be slipping back again. The economies of Europe are on a ‘slow and steady’ path of recovery, and China and India have continued what many in the popular press have called an ‘unsustainable’ level of growth.

There are now two divergent views in the currency markets. One has traders buying the dollar as a safe haven when the US data is bad, and selling dollars moving into ‘risk trades’ when the economic data in the US is positive. The other view that has recently started to catch on has currency traders selling dollars on bad economic news in the US, and buying the greenbacks when the data is strong. This is a more traditional approach, and focuses on interest rate differentials. When the US data is bad, the thought is that the FOMC will be forced to keep rates low. On the flip side, when the US data shows a stronger recovery, a potential FOMC tightening moves traders to buy the dollar. Choosing which strategy to use is determined by your thoughts on the global recovery. If you believe the global recovery can’t happen without the US consumer, then you choose the ‘safe haven’ approach. But if you feel, as I do, that the rest of the world is going to be able to recover without a strong US consumer, then your focus shifts back to interest rate differentials and the global growth story.

No matter which side you are on, it is clear that the US economy is not doing as well as the administration would like us to believe. Nobel prize winning economist Joseph Stiglitz was all over the wires this morning stating the obvious. He said the US economy faces an “anemic recovery” and predicts the government will have to push for another round of stimulus. The Obama administration took “a big gamble and it doesn’t look like it’s paying off,” Stiglitz told Bloomberg TV. “The recovery is so weak that it is not strong enough to generate new jobs for the new entrants in the labor force, let alone to find jobs for the 15 million Americans who would like a job and can’t get one.”

Today we will get another view of the US labor market with the Friday Jobs Jamboree. Non-farm payrolls are predicted to have fallen 65K last month after a 125K fall in June. Private payrolls and Manufacturing payrolls are expected to have risen during July, continuing a recent upward trend. But the unemployment rate looks to push higher to 9.6%. Before I get all of the emails in the Pfennig’s “Reply” box regarding this data, I will let you know that I realize these are the “official government numbers” and that the true rate is much higher! But the markets will react to these “official” numbers, so we still need to see what they say.

In addition to the jobs numbers, we will get data on Average Hourly Earnings and consumer credit. Both are good measures of US consumer health, and will likely show that the recovery is not moving along as quickly as most would like.

News out of Europe this morning paints a better picture for the euro. Two of the countries that had investors worried, Spain and Italy, both reported positive economic growth in the second quarter. Spain’s economy grew 0.2% from the previous quarter, and Italy’s GDP climbed 0.4%. While these numbers aren’t Asian-like, they do continue a trend of growth for two of Europe’s biggest economic worries. Another report showed that German factory orders surged more than twice as much as expected in June. From a year earlier, orders climbed 24.6%! Orders from Asia and Australia were credited for the big jump.

As expected, both the ECB and BOE kept rates unchanged during their central bank meetings yesterday. ECB President Jean-Claude Trichet sounded hawkish in his press conference following the ECB meeting, giving the impression he would be pushing for an end to the bond purchases the central bank has been making. He declined to comment on the ECB’s exit plans, but told reporters that “the available data for the third quarter are better than expected” and “the market is functioning a little bit better.”

Data released in the UK showed that manufacturing is increasing, though not as fast as Germany’s. UK manufacturing increased 0.3% from the previous month, ending the best quarter for factory production in more than a decade. The BOE kept interest rates unchanged, and continued the bond stimulus plan, which has pumped 200 billion pounds into the market. Governor Mervyn King is unimpressed by the recent data, and wants to “keep our foot firmly on the accelerator.” He is definitely in the Bernanke camp of central bankers, and is more than willing to risk an inflationary spike in his pursuit of sustained growth.

The announcement earlier this week that Russia would be banning all exports of wheat has the agri-commodities on a strong upsurge. Friend of the desk and mega-investor, Jim Rogers, was recommending investors buy gold and agricultural funds as he believes inflation will continue to accelerate. We agree, and suggest the currencies of those countries who will be able to fill some of the gap left by Russia’s decision. Both Canada and Australia supply a large amount of grain to the world’s masses, so the uptick in wheat prices should be a plus for both Canada and Australia. Another of our favorites, the Brazilian real (BRL), is a third country which should see a good increase in the value of their exports.

The Canadian dollar (CAD) also benefited from comments by Finance Minister Jim Flaherty. He said the recent rise in the loonie is not surprising, and makes sense given the strong economic fundamentals. More importantly, he stated the currency “would have to go significantly above parity before it became a concern.” Sounds like the loonie has a green light for further appreciation!

The Aussie dollar (AUD) is poised for a third weekly advance against the US dollar, and it is back trading near its three-month highs. Further advances may be limited by thoughts that the RBA will extend their pause in rate hikes. The central bank said inflation is not a major concern, as the nation’s economic expansion is unlikely to cause a big spike up in prices. But the recent move in both wheat and oil may cause the RBA to come back to the rate hike table sooner than they would like.

Aussie’s kissin cousin across the Tasman, the kiwi (NZD), was sold off overnight after a report showed that the jobless rate rose more than forecast. New Zealand’s jobless rate rose to a seasonally adjusted 6.8% in the second quarter from 6% in the previous three months. The recent data in New Zealand certainly don’t support higher interest rates, which had been priced into the kiwi. If the economy continues to disappoint, the kiwi could fall further.

To recap: There is a fundamental shift going on in the currency markets – and traders are beginning to move away from the ‘safe haven’ dollar buying, employment data don’t look good in the US. ECB and BOE keep rates unchanged, but Trichet pushes toward the exits. Grain prices move the Canadian dollar higher, and it gets the green light for further appreciation, and the Aussie dollar is up but the kiwi is down.

Chris Gaffney
for The Daily Reckoning

The Daily Reckoning