Has the Dollar Topped Out?

In the face of Thursday’s 200 point positive and negative swings in the Dow, it could be argued that the US dollar has been relatively stable if you only look at the daily change of the 3 major currency pairs. The EUR/USD rallied 100 pips, the GBP/USD was unchanged while USD/JPY fell 75 pips. This compares to multi hundred pip moves for all 3 currency pairs on Wednesday.

Even the largest market movers had a far milder move Thursday than Wednesday. On a percentage basis, the largest market mover was AUD/JPY which dropped 1.09% while it was CAD/JPY yesterday which dropped five times that amount. These moves however masks the volatility that we are still seeing on an intraday basis; the EUR/USD hit a new 20 month low while the GBP/USD fell to a fresh 5 year low.

Although it may be very tempting to say that the dollar has hit a top, especially against the Euro, in order for this EUR/USD rally to be real and for investors to be convinced to stop selling higher yielding currencies, we need to see stabilization in the financial markets and a return of confidence.

Keep an Eye on Job Losses

Even though the non-farm payrolls report is not due for another 2 weeks, all signs point to serious job losses and for that reason we are still concerned about the outlook for the US economy and by extension we are also wary of today’s rally in US equities. According to the Financial Times, more than 78,000 people could be laid off from Wall Street. For the world outside of finance, massive job cuts have also been announced by companies like Yahoo, Merck and General Motors. Although we will not get to the double digit unemployment rates that we saw during the Great depression, we do expect the current unemployment rate to climb to a new 5 year high. Since consumer spending is the backbone of the US economy, a weak labor market will depress spending, which should in turn lead to softer growth. Therefore even though buyers have returned to the equity markets, there will be plenty of reasons for them to bail once again.

Emerging Markets to Welcome any Dollar Correction

Any correction in the US dollar will be cheered by the emerging market nations who have had to take drastic measures to combat the dollar’s strength against their own currencies. The rally in the greenback has taken a big toll on the Brazilian Real, South African Rand, Hungarian Forint, Turkish Lira and Polish Zloty. In order to avoid a mass exodus out of their local currencies, central banks of some of these countries have been forced to raise interest rates. Since the strength of the dollar has been the primary catalyst for the sharp decline in these currencies, a correction would be welcomed by all of these nations because it would help stabilize their currencies and make their jobs a lot easier.

Oil Prices Could Bottom on OPEC Production Cuts

US existing home sales are due for release Friday but the biggest event risk is undoubtedly the emergency meeting by OPEC. Oil prices have firmed up today on the expectation of a 1 million to 1.5 million production cut from the oil producing nations. The price of crude has fallen more than 50 percent since its July highs, giving the OPEC nations a valid reason to cut interest rates. However since 2000, whenever oil prices have fallen by more than 20 percent on a rolling 6 month basis, production cuts have marked major turning points for oil prices. There is a decent chance that we have seen the bottom in oil prices and for the currency market that could fuel a rebound in the Euro and Canadian dollar.

Comments

[Lok Sang Ho:]

The US dollar is too strong. The yen is too strong. Today's Nikkei plunge is almost certainly due to the excessively strong yen. Free floating with capital flows that swing with a life of their own could be hazardous to the health of real economies. Wonder why the Bank of Japan and the Fed tolerate the unrealistically strong currencies. Certainly their weak economies and heavy debt load do not justify such strength. Japan's current account surplus had shrunk by a huge amount, and it is so export-dependent. The US already suffering from a plunge in consumption spending, certainly cannot afford to have exports undercut by a strong dollar. What are the central bankers up to?

2008 Oct 24 08:28 AM

[JasonC:]

The dollar has not peaked, it remains bid at rates to zero and will continue doing so. For the simplest reason - dollar debts will be repaid, many others will not be. Yen likewise, even more so, as a source of savings capital to the entire system. Oil will not be saved by OPEC, it could easily fall by half from here. This is about where it should have *peaked* even in the boom and bubble --- all the rest higher was utter craziness from the start, and merely destroyed about 10 years of future demand growth for oil.

As for what central banks are up to and what is behind the epic move in the Yen, the run has moved from first world banks, secured by now, to the third world and periphery, where destruction of bubble commodity prices and the reversal of speculative flows are smashing overleveraged borrowers. Argentina set it off, CDS on sovereign credits are the proximate fear of loss vehicle, and submerging markets generally will be smashed by this wave.

The IMF has already done deals for Iceland and Pakistan, and it has 3 others begging outside, and more behind them. The IMF has capital of around $200 billion to lend out, and individual cases are looking for $25 billion. You can survey the wreckage and do the math, but the long and short of it is, the IMF can only reliquify the sovereigns and keep the world trade system functioning, if its creditor-contributors pony up.

And Japan will lead the way on that. Japanese savings will go to the IMF, the IMF will lend to the likes of Poland, the loans will enable them to stay alive on their currencies and their sovereign debts without pulling boneheaded stunts like Argentina's or Iceland's. That will keep the sovereign CDS market from exploding.

Meanwhile, the true hard currencies that make it possible will continue to be bid. Dollar bonds even have rates on them --- just look at the state general obligations, or the financials (debt and therefore senior to even Uncle Sam's preferrred). Until all of those get back to well bid status, nothing else is worth anything.

2008 Oct 24 01:01 PM

[SW Richmond:]

While our fiat doesn't suck as bad as "their" fiat, it's all still fiat and therefore subject to ongoing debasement. The currency crises will begin elsewhere (ooops, they've already begun elsewhere) and IMF reserves are woefully inadequate for a global rescue. Iceland and Argentina could very well prove to be global Lehmans.

The strength of the USD is ultimately backed by the ability of the US Government to pay its debts. Those debts are climbing at about a $6 Trillion annual rate, according to the Treasury's public debt website (up $400 Billion in the first 3 weeks of October alone). We have not yet begun to try to build our way out of this ala NRA / WPA, but we will. There is not enough genuine capital left in the world to do this, certainly not for everyone.

In the final analysis what matters is who is exposed to whom, and how far the global ripples flow. If Eastern Europe takes down Western Europe (Austrian lending to Hungary etc) and if Latin America takes down Spain, who will remain?

This explains to me clearly why the no governments want to enforce full disclosure, and why opacity is the order of the day: it's a giant global game of "Last Man Standing". Whoever collapses last, wins (?). The West must ensure that Russia and China are left in such a deplorable condition themselves that they will have enough internal problems that can't make trouble internationally after the West itself collapses.

Ultimately, I fear (though I am increasingly convinced) that the US will default. There just isn't enough money, or economic activity, to pay off the debt the government is incurring.

2008 Oct 26 12:39 PM