Strength in U.S. Currency May Signal a Retracement

At the time of this writing, the almighty Buck was up by 1% or more against the Yen, the Euro, the GBP, the Loonie, and the Swiss Franc. It was up by less against those high interest rate currencies of Australia and New Zealand. Crude oil was up above $70 early, but it is now at $69. With the strengthening of the US Dollar, it seems likely to go still further downward. It is overbought at the moment. The fundamentals, especially the US unemployment number of 9.4%, do not support higher oil in the near term.

Perhaps more importantly the strengthening of the US Dollar indicates the return of fear. Mind you, the VIX is still hovering around 30, but fear has returned. The fear is not only for the US. The recent numbers from the Eurozone indicate that the GDP for the Eurozone was worse than first estimated. The Eurozone GDP was -4.8% year over year. Industrial production fell off 15.7% year over year. It fell off 8.8% since last quarter. The pre-eminent European economy, Germany, had its GDP fall by 6.9% year over year. This kind of data makes you wonder if the ECB is taking enough action to stem the economic fall. Notably the ECB did not lower its lending rates yesterday, when it had the chance to. It is no wonder the European recovery is slated to lag the US recovery by about 6 months.

This is another reason there should be no expectation of a near term surge in the Euro vs. the US Dollar. In fact the opposite is true. Unemployment is rising. The GDPs of both the US and Europe are still falling. Admittedly, there is occasionally some positive data. With each Fed meeting the numbers get worse. The recovery gets farther away. The latest Fed estimate for 2009-2010 calls for a -1.3% to -2.0% GDP growth for 2009 and a 2.0% to 3.3% positive GDP growth for 2010. The prior estimate for 2009 was about 0.8% higher. Plus, one must keep in mind that the Fed’s estimates have gotten worse at virtually every meeting of late. The same thing is happening in the Eurozone.

The difference is Europe is likely in deeper trouble, especially the weaker members. Latvia’s economy is expected to contract by about 18% this year. They cannot sell their bonds. Even the strong economies such as Germany are going south quickly (-6.9% year over year). This argues for strong stimulatory measures by the ECB. However, these have not been forthcoming. The ECB may have missed its chance. The ECB’s hard line against inflation may have cost Europe dearly. It did not lower its interest rate at its last meeting, even in the face of multiple European nations on the brink of failure. When the dominos start to fall, lowering the interest rate will do scant if any good. Much of the damage will have been done.

I am looking for very hard times ahead for Europe in the near term. These will impact the US, but to a lesser extent. The more stimulatory plans of the US government should likely prevent the very harsh death spiral we have all feared. It is unclear however, that that death spiral will be prevented in many parts of Europe. Usually lowering of a country’s (or a zone’s) interest rate will cause that currency to go down compared to others. It likely would have this time too for the very near term.

However, the failure to lower the interest rate in the face of the dire European economic times will likely have much more dire and longer lasting consequences. These consequences (poorer performing economies) should lead to a deeper and longer term devaluation of the Euro relative to the US Dollar. This is what was leading the European currencies lower against the US Dollar Friday. This, in conjunction with the more negative economic picture, will likely cause oil to go down (in US Dollar terms).

The booming US technology equities sector, which is strongly overbought currently, will likely lose its steam. If the US technology products are more expensive to Europeans, they will buy fewer US technology products. If the European economies are doing worse, they will buy fewer. Thursday was a sad day for Europe. It was also a sad day for US technology companies. It was a sad day for oil prices. By extension, it was a sad day for the S&P500, which is a very oil heavy index.

Oil surged Thursday on the relatively good economic news and the temporarily stronger Euro (due to the ECB’s inaction). However, this is likely a very temporary surge upward. The fundamentals say oil is overbought. The fundamentals say the world’s economies cannot afford to pay that much at this time (and still hope to recover from recession). The fundamentals say there is currently an oversupply of oil on the world market. The currency gains by the US Dollar Friday likely mean that the near term future for the European economies is negative (or seen that way). This is a strong signal for a near term move upward in the US Dollar.

It is also a strong signal for a near term move downward in oil and in the US equities markets. The fact that both oil and the US equities markets are currently very overbought (and the US Dollar very oversold) should make this move that much easier. The fact that there is approx. 5 times more capital raising (share dilution) in the equities markets today than a couple of years ago should make it easier for the equities markets to go downward. The fact that there are still many, many toxic assets to digest should make it easier for the equities markets to go downward (and take oil with them). I will be playing this strategy in various forms for the near term.

Disclosure: I am currently short USO.

Comments

[DONE_SONZ:]

The Swiss franc is the only one that has any real value.

Jun 07 08:09 AM

[DONE_SONZ:]

Assuming it is still backed by gold.

Jun 07 08:47 AM

[David White:]

I should have mentioned that the USO price chart is almost exactly at a peak price it reached in early January 2009. It is likely to encounter overhead resistance at this point. This is another good reason for a near term retracement of USO.

Jun 07 12:37 PM

[David White:]

The US Dollar ended the day up over 2% against both the Yen and the Loonie. It was up over 1.5% against both the Euro and the Swiss Franc (only 1.2% against the GBP). This is quite a move for one day. This is significant strength, especially if there is follow through next week. Oil ended the day at $68.35. Oil will likely ease further if the US Dollar continues to strengthen early next week as many are expecting. This should be good for my USO short position.

However, I will have to watch to see how much Treasury buying the Fed does. Most think that this could pressure the US Dollar even though it is currently over sold.

I am positing that the US Dollar will be stronger and oil lower through Tuesday morning. As Tuesday progresses, we will likely get a better idea of how much Treasury buying the Fed intends to do next week. This may then tip the scales back the other way, depending on the Fed actions.

I don't really have a good take on the Fed actions for next week. Bernanke's strategy has definitely been to try to keep mortgage rates low. However, excessive buying of Treasuries has started to have a contradictory effect. The monetizing of debt has started to make Treasury buyers demand higher yields. The higher yields are contradictory in a very real sense to at least the Fed objective of keeping the mortgage rates low. This in turn may put a damper on the Fed's desire to buy as many Treasuries. We will have to wait to see.

If the Fed does not buy appreciable amounts of Treasuries, the US Dollar seems likely to continue to strengthen throughout the week next week. The US Dollar is very oversold. If the US Dollar strengthens, it is likely oil prices will go down in response.

Jun 07 12:39 PM

[David White:]

So far today (Monday) the USD is up +.53%. More importantly for the oil short trade, the USD is up about 1% against both the GBP and the Euro (about 6am ET).

Also important for the oil short trade, it is getting more expensive to store oil on tankers. According to Bloomberg that price has gone up 28% since May 28. The premium for Brent crude for delivery in a month’s time compared with immediate supply has shrunk to 72 cents a barrel from as much as $1.16 a barrel a month ago. A notice of redelivery was issued for 7 of 33 supertankers storing crude. There may be as many as 60 supertankers storing oil. If an appreciable portion of these tankers opt to make delivery soon (and it sounds like at least 7 are going to), this should put significant pressure on the near term price of oil.

At the time of this writing, crude oil is down $0.83 on the day (Monday June 8).

Jun 08 06:02 AM

[David White:]

I covered as USO turned upward this morning. However, I am looking for a good place to get back in. USO will likely be rolling its contracts this week. That may mean that the near term price of oil will take a hit. If the supertankers are also delivering oil (converting from being floating storage tanks), this out to provide good downward pressure on the near term price of oil. Certainly rolling the contracts should at least cost USO money.

Jun 08 10:55 AM

[David White:]

Ireland's credit rating was downgraded today from AA+ to AA by Standard and Poors. In addition the government of Gordon Brown is in trouble (shaky at best). These two things are puting pressure on both the GBP and the Euro.

Jun 08 01:01 PM

[David White:]

The British Parliament re-affirmed the government of Prime Minister Gordon Brown yesterday. This should temporarily lift both the GBP and the Euro. The markets love stability. The markets were also likely cheered by the fact that the Parliament did not think Gordon Brown's government had been doing everything wrong. This is what a vote of no confidence would have meant. It would have meant Britain was financially lost. It would have called into question British banks stability, etc. This was overall very good news for the markets (if you are a bull).

Wholesale Inventories data comes out at 7am ET. Geithner testifies before the Senate starting at 7:30am ET. The ABC Consumer Confidence Index comes out at 5pm ET. We will have to see how these impact currencies and oil.

The oil stocks data come out tomorrow at 7:30am ET. That shoudl be a biggy for USO. I am expecting a build due to the increased costs of storing crude on tankers. Plus the crude prices are relatively high now. It is unclear that one would gain much by delaying delivery at this point. Prices could very well go down. It seems likely they will as crude storers deliver oil to cut down their expenses and their risks.

Jun 09 09:04 AM

[David White:]

The underlying technicals are still signalling a retracement for th enear term. The market indices held their own yesterday, but the broader market was down. Declining issues led advancing issues by a margin of 5/3 to 1. The volume ratio was less tilted toward the downside, but it was still bearish. Tomorrow may be a critical day.

Jun 09 09:32 AM

[David White:]

The Wholesale Inventories were down -1.4% vs. and expected -1.2%. This is bad for the US economy. It indicates that the economy is still shrinking. This means we can likely expect another bad GDP number for Q2. It is unclear exactly what effect this will have on the US Dollar. Europe will likely be experiencing the same thing. However, it is such bad economic news that it indicates that the economy cannot support high oil prices at this time. It indicates a continuing decrease in the demand for oil for the near term. This will likely supersede any minor curreny effects this news may have.

Jun 09 10:08 AM

[David White:]

USO is up today, but the On Balance Volume is -5.7M. This is one of those days that you wonder of GS is manipulating the market. Fortunately, GS doesn't own all of that oil stored offshore. Some of those owners will have taken advantage of the high prices. They will have delivered last week. This should show in the crude inventory numbers tomorrow (I expect a build). GS will have a hard time hiding that. They do not control everything.

Jun 09 11:33 AM