Yellen Brings the Dollar Down

It was a great day in the currency markets for investors who own currencies or metals, as the dollar slid versus every asset over the past 24 hours.

The big news driving the dollar lower was the ‘leaking’ of Obama’s pick for Vice-Chairmanship of the Federal Reserve. He apparently has chosen Janet Yellen, the Fed Bank of San Francisco President. Yellen has recently been sounding rather dovish on interest rates, and therefore her nomination has all of those who were expecting an early rise in US interest rates heading for the exits. At EverBank, we have never bought into this ‘US interest rates are going higher in early 2010’ camp. Yellen has pretty strong credentials, as she served as President Bill Clinton’s chief economist in the 1990s; and will certainly be approved by the Senate.

So what will her appointment to the Vice Chairmanship mean for the Fed policy? The Vice Chairman doesn’t get an extra vote, and their vote is still just one of several. The big difference is that the Vice Chairman gets a permanent vote on monetary policy, while the other Fed heads only get a vote one year out of every three as a regional Fed chief. Therefore, the Vice Chairman has three times more influence on Fed policy and the direction of interest rates.

And Yellen wants to keep interest rates low in order to continue stimulating our economy. Last month she said the US economy “still needs the support of extraordinarily low” interest rates. She is a strong supporter of Bernanke, and has been a key advocate of the massive expansion of the central bank’s balance sheet, even as some other regional Fed officials have been calling for a pull back of the monetary stimulus. Yellen spent much of her career at the University of California at Berkeley, and is considered a leading expert in the causes and implications of unemployment. This background has shaped her opinions on monetary policy, which she believes should be used to promote ‘full employment’ rather than ‘price stability’.

Obama will also get to appoint two other governors, giving him the ability to reshape the Fed’s seven member Board of Governors. I am a bit biased, but it worries me a bit when those directing our monetary policy are mainly from NY and California. The data shows that these are the exact areas of the country that are in some of the worst financial shape! Doesn’t it scare anyone else that these individuals were in leadership positions and directed policy in states that are now basically bankrupt? How about choosing some individuals who are from states that aren’t in dire financial straights? I know it is becoming increasingly more difficult to find any US state in good shape, but why do we continually pick folks from the places where the economic downturn has been the worst?

Speaking of financial leaders who were asleep at the switch and still got kicked ‘upstairs’ to try it again; Treasury Secretary Geithner is taking some heat in Europe. The EU has proposed regulating hedge funds and private equity funds that operate in Europe in an attempt to make financial disclosures more transparent. Geithner is vehemently opposed to the EU proposals, and has enlisted the backing of the UK. Geithner is afraid the tighter regulations will lead to discrimination against US firms operating in Europe. The Europeans continue to be upset about the role Goldman and other US banks played in attempting to bring down the euro (EUR). It will be interesting to see how all of this plays out.

The euro moved nearly a full cent higher in overnight trading on optimism that Greece’s budget crisis has been contained. The successful bond offering in Portugal seems to have emboldened traders who are moving back into the euro, believing the worst is now over. German Finance Minister Wolfgang Schaeuble helped strengthen the euro with some tough words for EU members who continue to flout debt rules. Shaeuble has endorsed Chuck’s idea of a European monetary fund to help deficit plagued states, but wants the lending to be tied to strict conditions. “Should a euro-zone member ultimately find itself unable to consolidate its budgets or restore its competitiveness, this country should, as a last resort, exit the monetary union.” Shaeuble wrote in today’s FT. Tough talk like this had led many to believe that even if Greek can’t fix their problem, they won’t destroy the euro, as in a worst case scenario, they would simply be thrown out of the EU.

The Swiss franc (CHF) was up versus the US dollar, but weakened a bit versus the euro after the SNB kept rates unchanged. While the interest rate non-move was widely predicted, the statement accompanying the rate announcement hurt the franc. The central bank said it “will act decisively to prevent an excessive appreciation of the Swiss franc against the euro.” This language has refueled the intervention fears and pushed the franc lower versus the euro.

The British pound (GBP) climbed higher versus the US dollar for a second day after a report showed UK housing prices rose in February. The increase was the fastest pace in more than seven years, with prices jumping 1.9% compared to January. But this report is in direct contradiction to other data which shows values have been falling recently. Apparently there are much fewer transactions, making the numbers volatile and causing many to believe this big positive number will be revised down. I say take advantage of any pound strength to exit, as this currency will continue to move lower in the long term.

Moving to this side of the pond, the weekly unemployment numbers came in a bit worse than predicted. 462 thousand applied for unemployment benefits last week, 2Khigher than estimates, but slightly less than last week’s number. Other data showed the trade balance narrowed slightly, but we still have a $37.3 billion deficit.

Today we are scheduled to get the US retail sales numbers, which are expected to have contracted a bit in February. The snowstorms are being blamed for what is expected to be a 0.2% decrease in retail sales after they rose 0.5% in January. A later report will probably show that business inventories and consumer sentiment rose.

Gold is up for a second day, as the dollar slide helped spur demand for precious metals. Gold has had a very close negative correlation to the dollar, moving higher as the US currency drops, and falling as the currency rises. So the drop in the US dollar versus the euro propelled the metals higher. The price of gold was also helped by a report that showed production in South Africa fell 18% in January from a year earlier. As with all commodities, a drop in production causes an increase in price.

Speaking of South Africa, RBC Capital released a report yesterday which predicted that the rand (ZAR) will rally 10% in the next three months. The report credits improving economic growth and the upcoming Fifa World Cup tournament with pushing the South African rand higher. The report predicts the rand will reach a high of 6.75 per dollar by the time the World Cup ends on July 11th. “Investors are going to push the rand stronger as we approach the world cup, which will attract quite a lot of money into the country”. We have seen a pattern of major events pushing the host country’s currency higher, as the Olympic host country typically gets a boost in the months prior to the event.

The other commodity currencies also had a good day, with the Canadian dollar (CAD) hitting a five-month high and the Aussie dollar (AUD) approaching its highest level this year. These commodity currencies were under selling pressure early yesterday on fears of a Chinese slowdown, but rallied in the afternoon and overnight. Traders seemed to have figured out that the reason the Chinese are looking to slow their economy is that their economy is growing at a good clip!!! This is a good thing for commodity prices, as a growing Chinese economy will continue to put upward pressure on commodity prices.

The New Zealand dollar (NZD) also benefited from a report which showed that retail sales increased for a fifth time in six months in January. Reserve Bank Governor Alan Bollard said yesterday that he might start raising borrowing costs around the middle of 2010 as the economy recovers. Interest rate differentials should continue to support the New Zealand dollar. With US rates remaining at their current low levels, investors will be moving toward countries that have stable economies and where interest rates will be rising.

To recap: With Yellen having a bigger say, US monetary policy will remain dovish for some time; the euro moved up over 1 cent as the Greek crisis passes; Gold finally starts to move higher as the dollar slips; commodity currencies will continue to take advantage of interest rate differentials.

Chris Gaffney
for The Daily Reckoning

The Daily Reckoning