Why Bad U.S. Statistics Are Good for the Dollar

Is there logic to Friday’s move in the Dollar? Despite atrocious job numbers and indications of a deepening American recession, the Dollar gained against all of its competitors except the Japanese Yen.

The United States unemployment rate jumped 0.4% to 7.2% in December. In February of last year the rate was 4.8%. In eleven months the percentage of the work force seeking but unable to find work has increased by 50%. American job rolls shed 524,000 paychecks in December with an additional 154,000 jobs lost in October and November according to the revised statistics. Employment in all categories except health care and government declined. Bad as the December numbers were they will probably worsen in the next three months as revisions and late reporting add to the total. The US economy shed 2.6 million jobs in 2008. This was the worst one year total since 1945, when 2.75 million jobs were eliminated as war production ended with victory in World War Two.

Yet in the face of these miserable statistics, or maybe because of them, the Dollar scored. The Euro lost 2.2% against the US currency, the British Pound 1.3%, the New Zealand Dollar 1.0%, the Australian Dollar 1.3%. On the principle trading side, the Dollar gained 2.25% against the Swiss Franc and 0.7% against the Canadian Dollar. Only the Yen moved higher against the US currency, appreciating 1.5%.

There are three rationales operating behind this Dollar move; each offers a different explanation for the currency effects of the world economic situation. We can call them the trade positioning and Yen cross crowd; the safe haven players; and the US recovery first nationalists. For very different reasons, each of these explanations boosts the Dollar when US economic news is poor. Perhaps it is surprising that negative economic news puts all three explanations in the strong Dollar camp but the logic is not complicated.

The trading factor is simple—it is the Yen crosses. Even if it makes no comparative economic sense for the Yen to have strengthened four figures against the Euro because of poor US job figures the reaction of the cross traders is by now an ingrained feature of the currency markets. ‘Risk aversion’ is the current shorthand for this reliable short term trade. If economic calm is ascendant or the news is moderate buy the crosses, if the reverse occurs, sell the crosses. Is this an image of the relative economic strengths of the Eurozone and Japan or a reflection of central bank rate policy? No. This is a straight forward reactive trade that has worked for years. This ‘risk aversion’ selling in the Yen crosses is the standard trading response to worrisome economic news. Though it is not a specifically pro-Dollar trade the over Dollar component of shorting the Yen crosses supports the Dollar against the Euro. Selling the Euro/Yen weakens the Euro against the Dollar and the British Pound as well as the Yen. That weakness is reflected in the Euro US Dollar rate as well as the Euro/Yen rate.

On Friday, the movement in the Euro after the Non Farm Payrolls release mimicked the Yen crosses. The top in the crosses and the Euro came at the same time, just after the NFP release. The percentage of the peak to trough drops in the crosses and the Euro was similar: Euro/Usd 2.45%; Euro/Yen 3.17%; Stg/Yen 2.77%; Aud/Yen 2.97%; Nzd/Yen 2.60%. These Yen crosses depreciated an average of 2.88%. The Euro fell 2.45%. The Euro/Usd declined 85% of the average drop in the Yen crosses. In contrast the Usd/Yen fell only 1.66% or 58% of the average in the Yen crosses.

A much greater percentage of the drop in the Yen crosses was absorbed by the Euro against the Dollar than was absorbed by the Dollar against the Yen. The Dollar gained 2.45% versus the Euro today but only lost 1.66% versus the Yen. One could say this puts a figure, at least for Friday, on the value of the second and third rationales for Dollar strength in the face of bad news. It is a measure of the combined safe haven and recovery first aspects of the competition between the US Dollar and the united European currency.

Another way to think about the impact of Yen cross trading on the Dollar is to imagine a Dollar move that stemmed from a factor which had minimal impact elsewhere -- say an unexpected Fed rate hike. Under those circumstances you would probably see a fall in the Euro against the Dollar and a rise in the Dollar against the Yen while there might be little movement in the Euro/Yen.

The key fact in assessing the unequal effect of increased United States economic risk on the Dollar is that US Economic risk is really world economic risk and as such it affects all currencies.

The second rationale is commonly called the safe haven or the flight to safety trade. The haven sought is comparative. There has been no country and certainly no industrial country that has not been touched by the recession and the financial crisis. If the US economy is headed for a deep recession the rest of the world will not escape. If the world financial system is suffering a prolonged credit drought the US has the greatest resources to overcome it. In this view, it is the US, with the largest and most productive economy, the world’s reserve currency and the most stable political system, that has the best chance of avoiding disaster.

The last rationale is more optimistic. The American Government recognized the severity of the financial crisis before any other. It has done more and is planning to do more than any other advanced economy. The economy is the first task for the new Obama administration. The Federal Reserve has been more active in gauging and surmounting the financial turmoil than any other central bank. Recessions, even depressions do not last forever. When the world economy finally turns around it will be led by the United States. Eventually US economic numbers will turn positive. Will Eurozone numbers then still be mired in decline? And if they are, will the Dollar commence a powerful rally? This rationale is a vote for the financial flexibility and economic potential of the United States.

It is peculiar that unrelievedly bad American economic reports serve to support the Dollar. But the logic does not focus solely on the US but on the US role in the world economy. If the world economic system is headed for years of turmoil then the US is best positioned to weather the disaster. If the world is plunging into a deep recession then the US is best equipped to emerge first. These are not facts; they are the perceptions. They may turn out to be true or they may not. But for the time being they are the rationales behind trading decisions. In the comparison between the US and its trading partners the Dollar still looks like the best bet to currency traders.

Comments

[Delojozafado:]

"the dollar gained"..."0.7% against the Canadian Dollar"
It would seem on the relative percentage basis the Loonie is in the same league as the yen. This is certainly not just killing the Loonie. As a matter of fact the Loonie was not that long ago flirting with $1.10 or 10% ABOVE par. It seems that Canada is a lot like the 20 or so states in the US that actually operated on balanced budgets during the good/better economic times. The difference between Canada and Japan however is in what you can purchase for yield in Canada. TRP, KYE or ENY in the oil patch. GLHIF in the utility business(95% renewable GigaWs). Natural resources are currently as oversold as they were just previously over priced. There are now dozens of opportunities to invest in Canadian shares for yield. The Cad$ has only a fraction of the "quantitative" currency expansion issues of the US dollar. Canada has run budget surpluses over the last few years. Unlike the basket cases of NJ,NY and Caaahhleeefornia Canada recently has actually raised enough taxes to pay their bills. Whether it is the Emerging market's or the US's infrastructure stimulus plans that drives the next basic materials rally the economies of Australian, Brasil, So Africa and Canada are going to benefit. By extension their Currncies WILL outperform! A position in GLHIF with an effective 6.8 yld looks pretty nice. As the US policy of quantitative easing drives the TBT higher you could be getting the same effect working for you in an investment that increases in value by 30% on the potential currency move alone. Then there's the really risky obscure ATBUF converting to a REIT. Bruce Flatt not Almighty!

Jan 13 11:09 AM

[OldLimey:]

Excellent analysis.

Jan 13 11:10 AM

[1422moboggie:]

It has been said "you have to risk something to gain more..." Our current economical situation dicates we must be steadyfast on beingbrave investors but keep the wolf away from our door.
We need to wage war against allowing our government to spend more investigating all their shortcomings and instead make it their priority to admend our trade policies and global agreement to make our dollar count.

Jan 13 12:07 PM

[VerGota:]

Given the euro's dominant position in the DXY (around 60%), this is really all about the euro, as the yen simply rises in a bearish, delevering market.
There is deep concern about the euro despite the ubiquitous "the price to be paid for a euro collapse and return to mark/franc/lira is just too high" song that CNBC experts sing. There is a deep tension between exporters (like Italy) and those dependent on a strong currency (Spain, Ireland), the latter being the ones that would go Third World in a second if the euro were gone. But sov spreads are widening and if we are going into a deep protracted recession, more countries will want to return to old days when devaluation was possible. Watch Italy.

Jan 13 03:28 PM

[Glen L.:]

Of the three rationales, the first (yen crossings) sounds like superstition, and the other two are based on unrealistic (perhaps chauvinistic) assessments of where the US now stands in the global economy. I fear that the dollar's current relative strength is illusory, and that the printing of trillions of fiat dollars will very soon result in devaluation via massive price inflation. Of course, just about all governments are "creating money out of thin air" now, and the inflationary effects will be world-wide, but the question is who holds all those dollars (many of which will wind up in the hands of our international creditors), what is their exposure as the dollar devalues, and what will happen when they start dumping those dollars back on the market? As opposed to US holdings (i.e., none) of the competing currencies?

Also, the assumption that the US has the world's most productive economy largely hinges, these days, on the crippled service sector. Where are all the factories that will lead the world out of recession?

Look East, young man.

Jan 13 06:06 PM