US Consumers are Worried
We finally had a bit of volatility in the currency markets yesterday, as conflicting data released in two separate reports moved the markets in opposite directions. The dollar started off the day drifting lower, as has been the pattern over the past two weeks. But during the late morning the dollar started gaining strength, and has barely paused its ascent overnight.
Many of you probably heard the news reports that home prices finally rose during the month of May, and this is what had the dollar on the ropes yesterday morning. The S&P/CaseShiller Home Price Index reported that home prices in the US rose ever-so-slightly in May compared to April. But if we look at the annual figures, home prices are still down just over 17% across the country. Media outlets trumpeted this ‘feel good’ story with many economists declaring that housing has now turned a corner. This is a good sign, as prices have to stabilize before the housing sector can recover, but it is hard to get overly excited about a 17% drop YOY. The monthly figure rose just 0.5%, reflecting the first monthly gain since July 2006. Another report showed the share of homes sold as foreclosures or otherwise distressed properties fell to about 31% in June, down from a high of 50% seen earlier this year. With unemployment still creeping up, and the US consumer continuing to save instead of spend, I am going to need to see a couple of months of stabilized prices before I am convinced housing is turning the corner here in the US.
Just an hour after the surprisingly good news on the housing front was received, consumer confidence numbers for July were released, and spoiled the party. Higher unemployment is being blamed for dropping just under three points from the Conference Board’s consumer confidence index. This was the second consecutive decline, and it shocked economists who had predicted no change. Our economy is still consumer driven, so this number resonates with investors who had started moving money back into riskier assets believing the economic recovery was well under way. But US consumers are concerned about the job markets, and will likely continue to keep tighter control of their spending. Despite the rhetoric coming out of the Chinese/US talks (more on this later), the administration is counting on consumers to help pull us out of this recession/depression.
But consumers have a right to be worried, and will likely continue to keep a tight hold on their wallets. After all, the economy has lost 6.5 million jobs since the recession began in December 2007 – the biggest employment slump in over 80 years. Official estimates predict double-digit unemployment by the end of this year, and our unofficial estimates have pegged the number in the double digits since the first quarter of 2009. Without good prospects for employment, US consumers are finally realizing the intelligence of being frugal. Savings rates in the US continue to climb, but while that is good in the long run (and exactly what I believe they should be doing) it doesn’t help fuel a quick turn around for the economy.
Investors and the administration worry that the higher savings rate and slower economic growth will lead to deflation, and have been hoping instead to see some signs of inflation. But a bit of deflation is really not that bad, and can actually be healthy for the economy. While he was in Vancouver last week, Chuck sent me the following quote from our friend Doug Casey regarding deflation…
“Deflation is actually a good thing, because in a deflation prices drop and money becomes more valuable, so deflation encourages people to save money. Deflation rewards the prudent saver and punishes the profligate borrower. The way a society, like an individual, becomes wealthy is by producing more than it consumes. In other words, by saving, not borrowing. And during a deflation, when money becomes more valuable, everybody wants money. They want to save. Whereas during an inflation, you want to get rid of the money. You want to consume. You want to spend. But you don’t become wealthy by spending and consuming; you become wealthy by producing and saving.
“Inflation encourages people to borrow, because they expect to pay the debt off with cheaper dollars. It encourages people to mortgage their future.
“The basic economic fallacy in this is that a high level of consumption is good. Well, consumption is neither good nor bad. The problem is the emphasis on consumption financed by debt – which leads to the national bankruptcy we’re facing. It’s much healthier to have an emphasis on production, financed by savings.”
I think Doug hit the nail on the head, but as he points out, most economists fear deflation and have convinced the administration that the only way out of our current recession/depression is to borrow and spend. Hopefully US consumers will continue to fight the urge to re-leverage, even if it does extend the downturn. A bit of pain now can and will avert a whole lot of pain in the future.
But the markets don’t like the thought of frugal US consumers so the stock market sold off, and investors ran for the cover of US treasuries sending the dollar higher. Asian markets continued the sell off overnight causing a reversal of the carry trades, which had just started to be popular again. Risk aversion is back in vogue, so the high yielding currencies that had been benefitting got sold off. The biggest drop was in the Australian dollar (AUD), which fell nearly 1% versus the US dollar. As you would expect, the South African rand (ZAR) and Mexican peso (MXN) also sold off, but surprisingly so did the Japanese yen (JPY).
Japanese retail sales fell for a 10th month in June, extending the longest losing streak since 2003. Deflation is still gripping the Japanese economy, and a report released earlier this week showed that corporate prices dropped 3.2% from a year earlier. As I stated earlier, a bit of deflation isn’t necessarily a bad thing, but it certainly stalls out any sort of economic recovery. The problem with deflation is that once it takes hold, it is very hard to combat. Japanese consumers have traditionally had one of the highest savings rates, and their economy has been treading water for a number of years. The Japanese are relying on the global economic rebound to help stimulate exports, which will drive their economy back up.
The ideal situation is some happy medium between the two extremes. A slow growth/ low inflation environment is what we should strive for. Not high growth fueled by high leverage, or no growth with very high savings rates. So the current swing by US consumers toward a higher savings rate is a good thing, as long as we eventually start spending these savings and keep leverage to a minimum.
Numbers to be released later today will continue to call into question the recovery of the US economy. Orders for Durable Goods in the US probably fell in June for the first time in three months. The major automobile factories shut down for part of the month, causing a drop in the overall number. Except autos, the number will likely be unchanged from the May figure. Mortgage applications were already reported this morning, and showed another dramatic drop. The ‘refinancing boom’ – which the government created earlier this year – has petered out, and unless additional stimulus money is thrown at home buyers, the housing recovery will be a long, drawn out process. And finally, the Fed’s Beige book will be released later today. This report details how the economy is performing in each of the Fed’s districts, and is expected to confirm that the US economy is starting to bottom out, but no rapid recovery is in sight.
An economy that seems to be starting to recover more rapidly is Australia, where central bank Governor Glenn Stevens signaled that rates might be rising sooner rather than later. “I’ve never seen written down or heard in discussion some rule that says we wait until unemployment is peaking before we lift the cash rate,” Stevens said in Sydney yesterday. Stevens also said that the economy may rebound faster than the central bank forecast six months ago as consumer and business confidence surges. The Aussie dollar touched its high for 2009 yesterday at 0.8338 before retreating back below 0.82 on the carry trade reversal. I would think any pull back by this currency is an excellent opportunity for investors to jump into this currency, which we predict will end up one of the best performers of the year.
Whenever I talk about the Aussie dollar, I naturally move to its kissin’ cousin across the Tasman, the New Zealand dollar (NZD). New Zealand central bank Governor Alan Bollard will probably match Governor Steven’s moves and keep rates unchanged at their meeting tomorrow. The recent reversal of carry trades has caused this currency to turn around, but as with the Aussie dollar, a move lower should be seen as a buying opportunity.
India left rates unchanged overnight, signaling an end to its deepest round of interest rate cuts. The central bank is concerned that inflation will creep up as the Asian economies recover. Interest rate expectations have turned the currency around as the Indian rupee (INR) has increased about 1.5% versus the US dollar during the last two weeks.