Rates Unlikely To Fall Much Further, Dollar To Find Support; Looking To Sell Commodities

We recently where asked by our largest client about the effects of the Canadian dollar on a private placement we are helping to facilitate. In the process of drawing up our broad strategy post placement we outlined a brief look into our current economic thinking. We thought readers might find it interesting.

The recent cut of 50 BP in the Feds Funds rate has caused the dollar to move sharply lower. Currently, the trading in short term Treasuries indicates the possibility of future cuts in the months ahead. It should be noted that this may be a poor indicator currently, as opposed to previous readings. In part due to the recent credit crunch driving treasuries lower in a flight to safety and need for liquidity with the absents of commercial paper. Should the FED continue to cut we see a continued slide in the dollar.

Currently, we see three polarized views developing about the future of the market and economy, as outlined below:

1) The credit crisis and housing slump has forced the economy into a mild recession and the Fed is acting accordingly. As such, inflation pressures are receding and the Fed will have the ability and need to cut rates further in order to stimulate the economy.
2) The credit crisis and housing slump have slowed growth considerably to the point of minimal expansion or shallow recession. However, monetary stimulus should not be injected at this time. Given the current state of world economic strength and the falling dollar, inflation is still the primary concern. Rates will need to rise again to slow a potential inflationary cycle, which has taken root. The falling dollar will spur demand through both imports and domestic consumption, as foreign goods are more expensive and US goods are cheap.
3) The credit crisis is coming to an end and the Fed has acted appropriately by injecting funds into the system, which will help to stabilize the housing market. Since the Fed has started to ease, history dictates that now is the time to jump into the market.

We partially buy into the first and second scenario. Given this view point, we don’t see rates falling much further. We believe the dollar will find a support level shortly. We think the US economy has decelerated enough to cause a moderate shift in various global interest rates and structural economic issues, like the US trade deficits.

As such, this ripple effect through the global economy has just started and will take at least the next 12-18 months to unfold. As economies in Europe and Asia begin to slow from high currencies and lack of demand for their goods, demand for commodities will moderate. Accordingly, this will further aid the US inflation picture considerably. Subsequently, foreign economies will have to lower rates to stimulate slowing growth.

At this point the US, having re-accelerated its economy through exports and cheaper commodities, will be in the process of raising rates. In short, the global business expansion cycle will start again.

As such, the implications for our portfolio strategies are very clear. We will be selling out of our commodities position shortly only to re-enter at a later date. Secondly, we see the carry trade lasting a bit longer. However, foreign central bank interest rate policies and global economic growth rates should be watched closely.

In short, we are looking to exit (DBV) in the Spring and potentially start to lower (EFA) exposure in the winter.