US Consumer Spending Helps the Peso

The dollar bears returned to the markets yesterday, as most every currency moved higher versus the dollar.

Confident investors kept the dollar on the run yesterday as they went shopping for yield. The commodity currencies ruled the day again, with Australia, Norway, and Brazil’s currencies all posting gains nearing 1.5% versus the US dollar. Greece successfully sold 5 billion euros worth of bonds in the first sale since the EU reached agreement on a stability plan. The sale emboldened investors who moved funds out of their ‘safe haven’ parking spots in the Japanese yen (JPY) and US dollar. It seems we are back to the risk on/risk off trading pattern that dominated the currency markets over the past year. Good news for the US or global economy means bad news for the safe havens of the US dollar and yen, while the opposite occurs whenever the global recovery is called into question.

Data released yesterday morning showed spending growth again outstripped income growth here in the US. Personal income was flat, and personal spending increased 0.3% in February. But even with the increased spending by consumers, inflation remains calm as the PCE Core figure showed no change during the past month. Another report showed that manufacturing activity in the Dallas region jumped 7.2% during March, after a small decline during the previous month.

While the increased consumer spending without a matching increase in income worries me, it was great news for those with a shorter-term outlook. More spending by US consumers pushed both the Mexican pesos (MXN) and Canadian dollars (CAD) higher. Mexico’s peso rose to the strongest level in nearly a year and a half on the thought that US consumers would be demanding more of Mexico’s exports. Mexico ships 80% of its exports to the US, so the increase in US consumer spending definitely benefits the peso.

The Canadian dollar also strengthened, trading near the highest level since July of 2008. While Canada has developed a strong trading relationship with China, the US is still its number one market; so good news for the US economy filters through to a stronger Canadian dollar. With investors in a positive mood throughout the globe, oil rallied almost $2 and helped those currencies that have strong exports of crude, including both the Norwegian krone (NOK) and the Canadian dollar. With good vibes running all over the globe, investors moved out of dollars and into currencies, which should benefit from renewed global growth.

But there are still some items that could throw the markets back into crisis mode. Greece will need to raise as much as 15 billion euros by the end of May, matching the amount it has raised since the beginning of the year. Another factor that could weigh on the global markets is the Fed’s plan to end their support of the US mortgage bond market. March 31st is the last day the Federal Reserve will be a participant in the ‘agency MBS’ market. 18 months ago, the mortgage markets went into a tailspin prompting the global financial crisis. In order to stabilize the market, Ben Bernanke brought the Federal Reserve’s unlimited buying power to the secondary mortgage markets. According to The Financial Times, the Federal Reserve has purchased $1.25 trillion worth of bonds in the past year, slighty less than a quarter of all bonds sold.

The program has worked, as mortgage rates fell immediately after the program was announced in November of 2008, and continued to drop reaching 50-year lows last December. Mortgage rates have been held well below where they would have been without the Fed’s trillion-dollar balance sheet. This has helped stabilize the housing market, which was in a free fall back when the Fed first started buying mortgage-backed securities (MBS). These lower rates have not only helped new homeowners, but have also calmed worries about all of the adjustable rate mortgages that would be subject to major adjustments if rates moved higher.

But what happens later this week when the Fed is no longer there to purchase these securities? Lenders need to sell these mortgages to free up cash to make more loans. Naturally, the loss of a buyer who was responsible for a quarter of all the sales is going to drive prices lower and rates higher. This has our friends over at Agora Financial worried. The following was in The 5 minute Forecast yesterday:

“This is likely to be a big thing,” warns The Richebächer Society’s Rob Parenteau. “The Fed has bought over $1 trillion on government-sponsored entity (GSE) debt from the private sector. Private sector investors have taken the money the Fed has created. ‘Given the yield on near cash instruments, we believe investors have turned around and invested the proceeds from their GSE sales to the Fed in risky assets. We also believe some of these investors have replaced their GSE positions with Treasury bonds.’

“So directly, the Fed has bid GSE prices up and suppressed GSE-related interest rates (think mortgage rates). Indirectly, the Fed’s money creation in the QE ops has suppressed Treasury yields and boosted prices of risky assets. At month end, then, a major prop beneath asset markets will go poof.

“What happens, then, when broker dealers, households and money market funds go to sell their GSE debt after March 31 and there is no Fed on the other side of the trade, with a bunch of blank checks, prepared to buy the GSE debt?

“Can you say train wreck?”

I look forward to getting The 5 every afternoon, it is packed full of great observations and always has some good ‘Pfennig Pfodder’.

The Australian dollar (AUD) turned in the best one-day performance versus the US dollar in over a month. I wrote a few paragraphs on the Aussie yesterday, so I won’t go into a lot of detail here, but just wanted to let readers know the Aussie is still on an upswing which is actually picking up some steam.

While I have expected the move higher by the Aussie dollar and kiwi (NZD); today’s move up by the pound sterling (GBP) caught me a bit off guard. The pound moved clearly above the $1.50 and touched $1.51 for the first time in a week. A report released this morning showed Britain emerged from recession in the fourth quarter at a faster pace than previously estimated. This was good news for Prime Minister Gordon Brown who is facing a strong challenge in the general elections which are just weeks away. Brown is desperate for data that shows the UK economy is recovering in order to keep the Conservatives a majority in the upcoming elections.

I still wouldn’t touch this currency, as there is just too much uncertainty surrounding it. Not only will the BOE need to figure out how to extricate itself from the quantitative easing programs, but the elections continue to be ‘too close to call’. Currency markets don’t like uncertainty, and volatility usually favors those looking to drive prices lower.

Chris Gaffney
for The Daily Reckoning