Currencies Race to the Bottom

by: Jack Miller

The GBP (Great Britain Pound) has jumped in front of the AU$, in the race to the bottom. The fall of the AU$ was arrested by the cut in AU short rates from 7.25% to 7%. The BOE continues to resist moving rates down and the GBP continues to fall. Since July 23, the GBP has fallen from 215 to 192 against the Japanese Yen (JPY). Since August 8, it has fallen from 2.05 to 1.909 against the Canadian Dollar (NYSEARCA:CAD). Since August 12, it has fallen from 1.28 to 1.23 against the Euro. Against the US Dollar, the Pound reached 2.000 on July 15 and has since fallen to 1.772!

One can look at respective yield curves to see the reason for the fall.

Japan Curve
6-months .97%
5-year 1.01%
10-year 1.46%
30-year 2.29%

US Curve
6-month 3.1%
5-year 3.0%
10-year 3.74%
30-year 4.36%

Euro Curve
6 months 5.25%
5-year 4.03%
10-year 4.14%
30-year 4.54%

GB Curve
6-months 5.75%
5-year 4.4%
10-year 4.5%
20-year 4.4%

Note the high 6 month rate in GB. The English really have their foot on the brakes. They are braking so hard that the 20-year rate is lower than the 10-year rate and equal to the 5-year rate. EU central bankers are standing on the brakes too, but not hard enough to push the 30-year rate down to the 10-year.

America entered its slow down long before England. The US brakes were locked at 5.25% from June 06 until August 07. The US has released but even now the US Libor 6 month rate is about equal to our 5 year rate. Treasury bonds in the US continue to rally. Junk bond rates are still very high, but about to fall.

Like an 18 wheel truck coming down the mountain, the brakes are starting to give off a putrid odor. The US truck has already hit the foot hill slopes and has let up, but the GB truck is still high on the mountain and the brakes are getting hot. GB needs to let up soon or their economic truck will stop in the middle of the highway and cause multiple wrecks.

Data from places like China is hard to get, but the reserve rate in China is doing the same work as the short rate in GB. China's economic truck has been speeding down the tallest of mountains for a long time. The bank reserve rate has gone from something like 7% to 16% in the past 18 months or so. China growth is going to slow from the 11 to 12% annual rate to perhaps as low as the 4 to 6% range.

The amount of fuel being used by these economic trucks is falling rapidly. Going down hill, they will certainly try to keep their motors running, but, even after they release the brakes, they will use less fuel for a long while. The US economy grew at 3.3% last quarter, but America has gone from using 22 million barrels of oil per day to less than 20 million per day.

One way the analogy to trucks coming down does not hold is that the harder the GB brakes, the faster the GBP falls. The danger in braking too hard is actually of speeding the fall. While Great Britain does not want to brake too hard, it is coming close. Housing construction in England is falling faster than in the US and industrial production has slowed and unemployment is on the rise.

Until there is a "wold wide weighted average release", bond rates and demand for resources will continue to fall. A bump up in the polls by McCain will bring rates down even faster (the veto pen threatens the big spending ways of congress). Prospects of a drilling bill in Congress will also bring rates down more. Investors should remember that the market runs well in front of the economic cycle. Big money investors will buy the rumor and sell the news. By the time the drilling moratorium is suspended, the bulk of the decline in oil prices and bond rates will be over.

Disclosure: None