US Dollar Settles Into a Trading Range

The currency markets rode out the rough waters of Wednesday and made it to a bit calmer seas yesterday. The dollar traded in a fairly tight range as reports released in the morning showed initial jobless claims remained just over 350,000, and continuing claims also remained steady. Both of these numbers were slightly better than estimates, but neither moved the markets.

We also got the personal income and spending numbers for January, which showed a slight drop in both spending and income. Again, these numbers were fairly close to estimates, and didn’t cause too much concern.

And a bit later in the morning, we got the ISM manufacturing data, which showed a drop from last month’s 54.1, to 52.4. This number would indicate the manufacturing sector isn’t as strong as some people thought, but the vehicle sales data, which was released a bit later in the day, offset the bad ISM number with a 900,000 increase in automobile sales during February.

The U.S. automobile sector has been held up by the administration as proof their stimulus efforts worked, but yesterday’s numbers indicate the biggest gains in market share during February were the European-based automakers, who posted a 8.5% gain year over year. Asian-based automakers’ share of the U.S. market fell 0.8%. Of the big three, GM had the biggest decline, falling 2.7% to an 18.3% share of the market.

This morning, we are seeing a bit more dollar strength with the euro (EUR) giving back the $1.33 handle and the Swiss franc (CHF) falling below $1.10. We don’t have any data releases here in the U.S., so the week will likely end on a fairly calm note.

The dramatic swings of Wednesday are in the rearview mirror, and perhaps the markets have adjusted to the reality that the Fed won’t be throwing another round of stimulus at them. Or perhaps the markets are hearing some hints that not all of the Fed Heads agree with Bernanke regarding the need for another round of stimulus.

Federal Reserve Bank of San Francisco President John Williams said the Fed should maintain an “extraordinary supportive policy” to reduce an unemployment rate that will probably exceed 7% for years. “This is clearly a situation in which we have to keep applying monetary policy stimulus vigorously,” Williams said yesterday. “Looking ahead, we may need to do more if the recovery falters or if inflation stays well below 2%.” Sure sounds to me as if QE3 is still an option.

Bernanke repeated his market-moving testimony yesterday, this time sharing his thoughts with the Senate. He again said elevated unemployment and subdued inflation mean interest rates will stay low, without offering a sign that the economy needs an additional monetary boost. But the markets seem to be keying on the San Francisco Fed Head’s words, and no matter what Bernanke may have indicated during the past two days, the equity traders are thinking, “So you say we’ve got a chance.”

The ISDA ruling, which I spoke about yesterday morning, came back in support of Wall Street (no real surprise there, is it?). The International Swaps and Derivatives Association said the debt swaps by Greece did not trigger the credit default swap agreements, as these debt restructurings were not considered a default by Greece. A default would have forced the underwriters of these CDS contracts to pay out to those investors who bought them for protection. But the CDS underwriters aren’t fully out of trouble, as the ISDA will now be asked to determine if a specific clause being used by Greece to force bondholders to all agree to the restructuring would trigger the CDS payments. We will keep an eye on this, but for now, Wall Street has dodged a bullet.

The euro is drifting lower in early trading today, as a report showed German retail sales unexpectedly declined in January. Sales, adjusted for inflation, fell 1.6% from December, when they increased 0.1%. Economists had forecast a gain of 0.5%, so the drop definitely surprised the markets. The sting was deadened a bit by the fact the sales rose 1.6% when compared with the numbers a year ago.

Rising oil prices definitely have everyone worried that the slow growth, which we have seen in both Europe and the U.S., may get squeezed out. As I reported yesterday, the numbers showed European inflation accelerated in February, to 2.7% from 2.6% the month prior.

Right now, Europe continues to be in worse shape than the U.S., and the IMF said in a report released today that the global economy faces “major downside risks” due to the financial stresses of Europe. But the report goes on to say these risks are fading, and while Europe will enter a “mild recession,” the rest of the global economy should continue to grow.

According to the IMF, the world economic expansion will slow to 3.3% this year from 3.8% in 2011. The euro economy is forecast to contract 0.5% this year, compared with growth of 1.6% in 2011. They agree with us that the engine of global economic growth will continue to be the emerging markets (mainly China and India), in which 2012 growth is predicted to be 5.4%, compared with 6.2% last year.

The Nordic currencies were hit overnight, giving back some of the gains they had booked during the first two months of 2012. I was reading a report on Sweden’s economy last night, and things are not looking good for Scandinavia’s largest economy. The report by an economist at Nordea Bank AB in Stockholm predicts unemployment will rise during 2012, and the Swedish economy will fall into a recession. Sweden’s economy grew 3.9% in 2011, and the central bank has forecast positive growth of 0.7% for 2012. But the folks over at Nordea Bank say Sweden’s reliance on trade with Europe (70% of exports) and the European debt crisis will cause the Swedish economy to contract. A report released yesterday showed fourth-quarter GDP in Sweden shrank 1.1%, which supports Nordea Bank’s predictions.

A report yesterday showed Norwegian manufacturing accelerated at the fastest pace in nine months, helped by the rising price of oil. Unlike Sweden, Norway has been shielded a bit from the negative impacts of the European debt crisis thanks to their large petroleum industry. Norway is the seventh largest oil exporter, and the rising crude oil prices have helped push the Norwegian economy forward.

The purchasing managers’ index rose to 56.9 in February, from 54.7 the previous month. A reading above 50 signals an expansion. And unlike the Swedish krona (SEK), the Norwegian krone (NOK) has been tracking higher, reaching the highest level in almost nine years versus the euro. A strong and growing economy combined with rising oil prices and some of the strongest underlying fundamentals should support the Norwegian currency in the long run.

Things were looking better for investors in the Brazilian real (BRL), as interest rates were inching back up and the currency had returned a healthy 8.55% during the first two months of 2012. But Brazil’s leaders aren’t happy with the strong moves by the real, and are renewing their efforts to slow the currency gains. Finance Minister Guido Mantega reminded reporters yesterday that Brazil has many means to contain gains in its currency.

The government refrained from taxing direct investments into Brazil, and instead imposed a levy on foreign loans and bonds that mature in three years or less. Previously, the tax had covered only foreign borrowings of up to two years. Neither Chuck nor I are big fans of governments trying to use tax policies to adjust the value of their currencies, and investors will have to continue to be cautious when looking at the Brazilian real. The problem is yields in Brazil are still good, and demand for the currency continues to put upward pressure on the value of the real, a good combination for those investors who can accept the risks of government intervention.

The Australian dollar (AUD) hit a nine-month high versus the yen (JPY) and pushed higher versus the U.S. dollar, as the Reserve Bank is predicted to keep rates on hold. The RBA will be meeting next week, and recent global inflation pressures will likely prevent them from lowering rates. While China’s growth has slowed, it has not had the ‘hard landing’ many have been predicting. China will continue to grow at close to double-digit rates, and this growth will continue to support commodity prices and the value of the Australian dollar.

We have had some fairly good news for global economic growth recently, and this news has increased investor confidence. As investors have become more confident, they have been moving back into the “carry trade” that dominated currency markets over the past several years. Volatile markets are not good for carry trade investors, as they look to benefit from interest rate differentials. Higher-yielding currencies are the benefactors of the carry trade, and the South African rand (ZAR), New Zealand dollar (NZD) and Aussie dollar are some of the favorite currencies of carry trade investors. If investors continue to believe that global growth is here to stay, these higher-yielding currencies could become some of the best performers.

Then there was this. Several readers pointed out my error in trying to tie the big move in gold on Wednesday to Bernanke’s comments. As many of you pointed out, Bernanke’s comments may have been the spark to start the selling in the equity markets, but gold sold off due to a major futures sell order that shocked the markets and pushed them into a free fall.

One reader pointed out that Morgan sold 10,000 gold contracts short on Wednesday for Asian clients. I am never a big conspiracy theory guy, but when you have unexplained moves like we had on Wednesday, the old saying “Where there smoke. there is fire” comes to mind. A couple of your readers sent me this link, which gives Jim Sinclair’s views of the events on Wednesday.

To recap: The dollar settled into a fairly narrow trading range, but is starting to drift higher today. San Francisco Fed head is keeping the possibility of QE3 alive, and the ISDA gave Wall Street some good news concerning the Greek default. The IMF says Europe will slip into recession in 2012, but the global economy will continue to grow. The Swedish economy is in trouble, but the NOK is still strong. Brazilian leaders are searching for ways to stem the real’s appreciation, but they are having trouble swimming against the tide. The commodity currencies have a good day. Readers point out my error in blaming Bernanke for the massive sell-off in gold (although most agree he is probably still involved in some way).

Chris Gaffney

for The Daily Reckoning

The Daily Reckoning