What to Expect From the Dollar in 2009

2008 Price Action: It has been an exceptionally active year in the foreign exchange market as currency volatilities hit record highs. In the first half of the year, everyone was worried about how much further the dollar would fall but in the second half of the year the concern became how much further the dollar would rise. More specifically, after hitting a record low against the Euro in the second quarter, the US dollar surged to a 2 year high against the currency in the beginning of the fourth quarter. From trough to peak, the dollar index rose more than 23 percent in 2008.

3 Themes for 2009: The US economy and the dollar’s fate in the years ahead could be determined by what happens in 2009. We are focusing on 3 big themes that will impact the US dollar and each of these themes encompasses a lot.

1. U or L Shaped Recovery: The US is in recession and the slowdown is expected to deepen in 2009. Before a recovery is even possible, the economy has to work through more weakness and negative surprises. Non-farm payrolls declined by 533k in November, sending the unemployment rate to a 15 year high of 6.7 percent. With many US corporations forced to tighten their belts, the unemployment rate could rise as high as 8 percent. We expect this to happen because over the past 50 years on average, recessions have boosted the unemployment rate by 2.8 percent. When the current recession started in December, the unemployment rate was 5.0 percent. If you tack on 2.8 percent, that would drive the unemployment rate to at least 7.8 percent.

Therefore non-farm payrolls could double dip, just as it has in past recessions. In this case, we would expect a rebound followed by another sharp loss that rivals November’s job cuts. A rise in unemployment spreads into incomes, spending and then usually leads to more layoffs. We need to see this toxic cycle end before we can see a recovery. Consumer spending has already been very weak and the trade deficit is widening as the dollar strengthens. As the 2 primary inputs into GDP, we expect fourth quarter growth to be very weak. The strength of the US dollar in Q3 and for most of Q4 will also take a big bite out of corporate earnings, leading to disappointments for the stock market. This is why we expect more weakness in the US dollar and the US economy in the first quarter of 2009. However towards the middle of the second quarter, we may begin to see the US economy stabilize as it starts to reap the benefits of Quantitative Easing and President Barack Obama’s fiscal stimulus plan. New Administrations usually hit the ground running and as such we fully expect the rest of the TARP funds to be tapped shortly after his inauguration. The shape of the US recovery will have a big impact on the price action of the US dollar and the path to a stronger dollar will be through a weaker one.

The following chart illustrates the double-dip trend of non-farm payrolls during the 2001 recession.

2. Safety vs. Yield: The dollar’s rally in the second half of 2008 has been largely driven by risk aversion, deleveraging and repatriation. In other words, despite the next to nothing yield offered by dollar denominated investments, a flight safety into US dollars and government bonds has kept the US dollar from collapsing against
currencies like the British pound, Canadian and Australian dollars. The concern for safety was so high that investors were willing to take negative yields just to park their money with the US government. A bubble is brewing in the Treasury market and any improvement in risk appetite will take the market’s focus away from safety and back to return on money at which time ultra low interest rates could become a detriment for the US dollar. The dollar’s performance against other currencies would be contingent upon growth in the rest of the world. For example, if the UK economy is in the process of recovering, demand for yield and the prospect of return could send the GBP/USD higher, but if the recession in the Eurozone deepens, then the Euro may no longer be the flavor of the month.

3. Compression in Interest Rates and Volatility: Volatility in the currency market hit a record high in 2008 but in 2009 we expect the volatility to compress as interest rates around the world converge. Much of the volatility this past year has been spurred by speculation about how much various central banks would cut interest rates. As they run out of room to ease, we may stop seeing monetary policy surprises which can eventually lead to stabilization for carry trades. Don’t expect this to happen in the first quarter however as many central banks are still expected to cut interest rates. The Fed’s rate cuts have long been a big driver of market volatility and now that risk is off the table. When the monetary and fiscal stimulus start to impact the US economy, the market may actually start talking about a rate hike in the US. Interest rates cannot remain at zero forever, especially if inflation starts creeping higher in the second half of the year.

Growth: Although we expect the US economy to start its slow recovery in the second half of 2009, GDP growth next year will still be negative. Retail sales and non-farm payrolls will be particularly ugly in the first quarter, but we are optimistic that monetary policy and fiscal stimulus will begin to help the economy. The record decline in mortgage rates should also help to stabilize the housing market in 2009. Something between a L and U shaped recovery is likely.

Inflation: Deflation is much more of a problem for the US economy than inflation. Oil prices are more than 75 percent off their highs. As a result, we have seen either flat or negative consumer price growth every month between August and November. The December numbers have yet to be release, but there is no reason to expect CPI to be positive. Since the beginning of the year annualized consumer price growth has fallen from 2.1 percent to 1.1 percent. The US economy has not officially hit deflation, but with commodity prices continuing to fall and consumer demand slumping, deflation will become a greater risk than inflation in the first half of 2009. However this may change in the second half as Quantitative Easing, fiscal stimulus and hopefully a weaker currency boosts inflation.

Monetary Policy: US interest rates have fallen 400bp from 4.25 percent to 0.25 percent in 2008. For most people, interest rates at 0.25 percent are as unattractive as zero interest rates. With US rates pretty much at zero, the Federal Reserve has informally adopted its own version of Quantitative Easing. Some people may even argue that the Fed has been pursuing this strategy for months now. In conjunction with the Treasury department, the Fed has doubled their balance sheet in the past 3 months to more than $2 trillion. They have done this by purchasing direct equity investments in banks, easing standards on commercial paper purchases, made efforts to relieve institutions of their toxic asset-backed securities and are now considering buying Treasury bonds and agency debt. By buying these assets, they are adding money into the financial system. Like the Yen, Quantitative Easing exposes the US dollar to significant downside risks because the Federal Reserve is basically printing money and using that money to flood the market with liquidity, eroding the value of the dollar in the process. However it is a step that the central bank needs to take to stabilize the US economy and to prevent a deflationary spiral. The central bank will not be worried about a weak currency and will in fact welcome one because they know that a weaker currency is like an interest rate cut in many ways because it helps to support and stimulate the economy.

Comments

[Prudent Man...:]

Dollars trend? Read Bernanke's lips - down!!

Say no more as the printing press is running 24/7.

2008 Dec 29 12:17 PM

[Smarty_Pants:]

"The central bank will not be worried about a weak currency and will in fact welcome one because they know that a weaker currency is like an interest rate cut in many ways because it helps to support and stimulate the economy."

... by robbing savers and investors of their purchasing power.

Great. Nothing says "we care" like debasing your currency.

2008 Dec 29 02:06 PM

[Henrique Si...:]

Down. There is no other way.

2008 Dec 29 03:12 PM

[NOWHEREMAN:]

Smarty? what would your solution be.

Not being facetious, just would like to know.

2008 Dec 29 05:15 PM

[Asbytec:]

The dollar might fall, and it might fall dramatically. The Gold bugs seem to almost wish it. But, I assert the dollar's future is unclear at best.

We are in uncharted waters and volatility rules the day. Wealth is being destroyed and money lost. Credit is tight and trade with China is being strained. Seems "beggar thy neighbor" is just coming into vogue. (Okay, at best it's being played selectively, now.)

While MZM growth stalled in the second half of 2008, it has grown a bit since. But, money velocity is still down and many firms and consumers are deleveraging.

I have asserted the dollar's future depends on the amount of time it takes to get credit markets flowing. There are arguments out there that state banks prefer to retain money over the coming quarters to cover their solvency issues rather than lend. And this may take some great while to recover.

During this while, the velocity of money will be low and the actual money supply should contract despite Fed injections. If "deflation" is with us for most of 2009, well, the dollar should regain some of it's prior strength. However, if the credit markets start flowing soon, I suspect the gold bugs will make a killing.

It's all in the timing. I suspect deleveraging will take some time and housing prices will have to show signs of a bottom, despite the markets and the coming sucker rallies. Volatility will be with us through H1 09, I am sure. The dollar will be volatile, too.

2008 Dec 29 10:48 PM

[thatguy57z:]

this will give you some in site how it is going to start working. and how they've all ready have it moving foreword go to.
www.youtube.com/watch?.... copy and paste to your web browser , or click on my website


On Dec 29 10:48 PM Asbytec wrote:

> The dollar might fall, and it might fall dramatically. The Gold bugs
> seem to almost wish it. But, I assert the dollar's future is unclear
> at best.
>
> We are in uncharted waters and volatility rules the day. Wealth is
> being destroyed and money lost. Credit is tight and trade with China
> is being strained. Seems "beggar thy neighbor" is just coming into
> vogue. (Okay, at best it's being played selectively, now.)
>
> While MZM growth stalled in the second half of 2008, it has grown
> a bit since. But, money velocity is still down and many firms and
> consumers are deleveraging.
>
> I have asserted the dollar's future depends on the amount of time
> it takes to get credit markets flowing. There are arguments out there
> that state banks prefer to retain money over the coming quarters
> to cover their solvency issues rather than lend. And this may take
> some great while to recover.
>
> During this while, the velocity of money will be low and the actual
> money supply should contract despite Fed injections. If "deflation"
> is with us for most of 2009, well, the dollar should regain some
> of it's prior strength. However, if the credit markets start flowing
> soon, I suspect the gold bugs will make a killing.
>
> It's all in the timing. I suspect deleveraging will take some time
> and housing prices will have to show signs of a bottom, despite the
> markets and the coming sucker rallies. Volatility will be with us
> through H1 09, I am sure. The dollar will be volatile, too.

2008 Dec 30 03:54 AM

[Asbytec:]

Thanks for the video and the link. I am not really a conspiracy theorist, but I am open minded. I'll take in what people have to say then make an independent decision, as I suppose you and most others on this site do.

2008 Dec 30 06:59 AM

[Asbytec:]

I guess I don't doubt there are a few powerful people running the show, maybe behind the scenes. But, I still find some things hard to swallow.

Interesting video, though. I do not understand why the Ford foundation and the Carnage Endowment would openly discuss such a topic with an investigator...to allow their minutes to be read. I am sure the head of the endowment and their lawyers would have some knowledge of what was in those minutes. Ironically, I do believe in a deliberate dumbing down of Americans. So...

But, it's off topic, unless one wishes to assert that this same movement has plans to debase the dollar. I might add, that would be easy enough to do by calling in the Fed chairman and winning him over to the idea. I might also add it has been highly unsuccessful, given the movement has had some number of years to carry this out and a (presumably) willing Fed chairman Greenspan to help. But, that would be a stretch on my part to presume such a thing.

I do not think Bernanke's actions are an covert attempt to debase the dollar as much as a sincere interest to save the economy from depression...at all costs. Could be...but I am just not buying into it at the moment.

2008 Dec 30 07:50 AM

[NOWHEREMAN:]

Asb: there are a few ifs.

If the ECB doesn't lower rates soon=lower $
If Oil rises = lower $
If the Israeli conflict escalates = higher $
Ditto and oil rises, Good golly miss molly! will that be a wash?


Are all of the above part of a huge Consipiracy? YUP.

2008 Dec 30 08:54 AM

[retired avi...:]

"The dollar’s rally in the second half of 2008 has been largely driven by risk aversion, deleveraging and repatriation. "


Why do you say repatriation strengthens the dollar? It seems foreigners sending dollars back to the US by selling them to get their local currency back would weaken, not strengthen, the dollar.

2008 Dec 30 01:29 PM

[Asbytec:]

Aitvaras, I understand your points.

I believe the ECB will ease, albeit hawkishly. I've heard mixed reports they are doing better than expected, but I also understand they have the same banking problems we have and (apparently) agreed to coordinated action to stem global meltdown. They also seem to understand lowering interest rates did little to help monetary velocity.

I believe they have already played the first round of beggar thy neighbor by adjusting the spread on deposits and loans. It did stem the rise of the euro, something they seem concerned about. Germany, after all, is a major exporting nation, more so than the US.

I also assert USD velocity is down along with a contraction of total money supply. Folks are spending less and banks are lending less. Banks are strapped with asset write downs and selling assets at a loss. Institutions and consumers are deleveraging. Fed liquidity is locked up in vaults. So, money seems to be disappearing and new money is not circulating. To what extent compared to the total money supply, I am not sure. But, it's enough to cause (at least the fear of) monetary deflation.

So, the future of the dollar seems unclear. During all this, gold seems to have a hard time touching $900/oz. If things continue in a downward spiral, $20pbl oil seems more likely than $200pbl, at least in the foreseeable future.

But, a conspiracy to debase the dollar? Na, I doubt there is a conspiracy. If it happens, it will happen overtly because of Fed and government policy. We may see some level of inflation once credit markets start moving. Again, it's all in the timing. Much depends on how long will this "healthy" deflationary spiral continues. (Recessions are good, we need recessions to clean house.) We need to get our debt to GDP ratio down to continue with growth.

Mohbull, I believe dollar repatriation through fair trade does strengthen the dollar. It takes dollars out of circulation in the forex market. It does to serve to replace dollars with the importer currency changing the supply of both, as you probably already know.

Obama is a fair trader, so let's see what fortune he has trying to get China to import more. I doubt he will be successful in getting the RMB to float, as many prior attempts were unsuccessful. So, if the dollar falls, China will be hard pressed to keep pace devaluing the RMB.

Obama also wants to invest in science and technology, hopefully giving us something to export to other nations. This unfair trade policy of "we buy from you and you use our own dollars to buy us (not buy from us)" has got to end.

2008 Dec 30 07:45 PM

[NOWHEREMAN:]

Mr. Pinelli: you have decided to interpret what I said to someone else in your own particular pugnacious way.

Therefore:

"All paper currencies are hitting the skids" how can you tell since they are ALL hitting the skids? Relative to each other, therefore, none of them are "hitting the SKIDS" by your own definition.

I did not criticize anyone, I asked Smarty very politely if he had a solution.

And as far as Asbytec is concerned, he/she understood what I said even if you were too dense.

As far as I am concerned, I do not try to persuade anyone that my stock selections are the best but I do explain why I picked and own them and why I still do. I've provided opinions on many that I don't own, both pro and con, so that others can see both sides of any recommendation and are not blindsided by someone trying to glorify themselves.

Solutions? to what pray tell?

Do the words "Uncharted Waters" mean anything to you? Hypotheticals are just unapplied possibilities.

Please show me just one Solution from anyone that will solve everything. Solution defined: A statement which solves a problem.

You, yourself, are Pushing every conceivable type of investment because you do not have a clue as to what will or will not work.

But don't worry, I'll start on your track record as soon as I can. It will speak for itself.

2008 Dec 30 10:16 PM

[Maxe Paul:]

It appears that everyone says there will be an inevitable weakening of the dollar later next year. What if we see a W double dip recession where we see a weak dollar going into 2009 (and a suckers rally) and again the dollar strengthening later in the second half, with a repeat of the bear market hitting new lows. I invite people to look at the chart of the 1929 crash at Wikipedia to get the jist of what i am suggesting.

Jan 02 05:55 AM

[NOWHEREMAN:]

First day of the New Year:

Israeli conflict excalates and Oil rises but the Dollar rises also because wars tend to drive money into dollars.

Gold drops because it is priced in dollars. What is the intinsic value of gold, if it drops as oil rises?

Jan 02 07:19 PM