Forget About a V-Shaped Recovery. Maybe a W. Or L. And What About $? 20 comments
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The volatility that we have seen in the currency, stock and bond markets this past week has not been for the faint of heart. The Dow Jones Industrial Average fell 500 points on Monday, but instead of continuing lower over the course of the week, it staged the biggest two-day rally in 5 years. Three to four hundred point swings in the stock market have become the norm this week as surprises and disappointments from the US government keeps traders on their toes.
The current Administration has thrown everything but the kitchen sink at the markets, and based upon the recovery that we have seen over the past two trading sessions, something has worked. The most powerful of which are probably the Securities and Exchange Commission’s temporary ban on short selling and the hope that Paulson and Bernanke will deliver a new groundbreaking rescue plan that will include a bail-out fund that sops up all of the troubled paper. This has forced a massive short squeeze that drove stocks up more than 750 points in 2 days. Although there could have also been some genuine buying, the rise in gold prices suggests that some investors are still nervous. With no details disclosed at his press conference on Friday, it will certainly be another long weekend for US Treasury Secretary Paulson.
Don’t Expect a V-Shaped Economic Recovery, Maybe a W or L
The main takeaway from the recent developments is that we will not see a V shaped economic recovery. According to the data released this past week, the housing market and the manufacturing sector are still in trouble. Durable goods, the final numbers for second quarter GDP, new and existing home sales are due for release in this coming week and we expect the data to confirm the weakness of the US economy. Layoffs will rise, consumer spending will slow and corporate profitability will decline for at least the next 3 to 6 months. A recovery usually comes in one of four forms – U, V, W or L. We believe that in the current case of the US economy, we will probably see a recovery that looks more like a W or an L.
Investment Banks: 3 Down, 2 to Go
Of the top 5 investments banks on Wall Street, 3 have disappeared this year – Merrill Lynch (MER), Lehman Brothers (LEH) and Bear Stearns. The last ones standing are Morgan Stanley (MS) and Goldman Sachs (GS). [Citigroup (C) and JPMorgan (JPM) are considered universal banks since they have commercial banking divisions]. With Morgan in merger talks, there could end up only being one independent player left in the market. For banks to consolidate is not a surprise, but their consolidation now is more of an act of desperation than anything else.
However the pain is probably not over, with more write-downs expected over the next few months. Barrons estimates that there will be another $150B of write-downs before we are done. This will stress the markets as well as central bankers and put a full fledged recovery in both the economy and financial markets at risk.
How Does this Impact the US Dollar?
The US government’s destruction of its balance sheet is ultimately negative for the US dollar especially as the budget deficit continues to grow, but on a shorter term basis, we are seeing a very non-uniform performance in the US dollar. On Friday, for example, the greenback strengthened against the Japanese Yen but weakened significantly against many of the other major currencies.
We continue to believe that the outlook for the US dollar has changed because commodities are rebounding and the greenback has lost its safe haven status, and therefore we have probably seen a top in the US dollar. Unless the European Central Bank agrees to global easing, we should see the EUR/USD revert to a period of range trading, although that range will probably be an extremely wide one characterized by sharp intraday swings. Expect more surprises and volatility in the new week if Paulson unveils his new plan.
EUR/USD: 1.45 POSSIBLE, 1.50 UNLIKELY
After hitting a low of 1.3882, the EUR/USD has seen a material recovery this past week.The dynamics that were pressuring the EUR/USD lower have changed, which means that fundamentals and technicals now support a turn. Although the Federal Reserve is sterilizing their liquidity injections, which means that they are not printing money, currency traders are selling the US dollar as if the printing presses have come on.
Oil prices are trading back above $100 a barrel, gold prices continue to rise and the Federal Reserve is moving closer to cutting interest rates.These macro developments are diametrically opposite from the factors that drove the dollar higher between the middle of July and the first 2 weeks of September.The Eurozone economy will no doubt be impacted by the US banking crisis, but the members of the ECB continue to warn investors that they are not relaxing their focus on inflation. Until Trichet gives in and agrees to global easing, the bottom in the EUR/USD’s latest sell-off may not be challenged. However at the same time, we do not expect the EUR/USD to break 1.50.
In the week ahead, the big releases in the Eurozone are the German IFO report, manufacturing and service sector PMI. Meanwhile, the Swiss National Bank kept interest rates unchanged at 2.75 percent. The uncertainty in the financial markets leaves their bias neutral.
BRITISH POUND SOARS AS BARCLAYS AND LLOYDS RAISE CAPITAL
On Thursday, the British pound soared following a stronger retail sales report, and Friday, that strength was extended by another unexpected surprise. Barclays Bank (BCS) announced that they have raised GBP700 million in new capital, while Lloyds raised GBP767 million through a share sales. This leaves Barclays and Lloyds with some of the healthiest balance sheets amongst the banks in London. For Lloyds, this announcement follows their agreement to rescue HBOC on Thursday. UK banks are looking golden compared to their US counterparts, and for that reason we have seen a sharp rally in the British pound and the UK stock market.The FTSE rose 8.84 percent on Friday, the single largest one-day rise since 1987.
Looking ahead, there is no major UK economic data on the calendar next week. We are only expecting some more recent reports on house prices.
JPY: BE CAREFUL OF THE CARRY TRADE RALLY
For the second day in a row, carry trades staged an impressive rally.The Australian dollar rose a whopping 5.6 percent against the Japanese Yen while the New Zealand dollar rose close to 4 percent. This is largely due to the sharp gains in US stocks, but we caution traders against reading too much into this rally.
A healthy environment for carry trades require: 1) Strong risk appetite, 2) Global tightening and 3) Low volatility. In the current market environment, risk tolerance is still a problem, central banks around the world are contemplating lowering interest rates to ease the strains in the financial markets while volatility has shot through the roof. Unless these dynamics change, it may be difficult for the Japanese Yen crosses to sustain their gains.
In the week ahead, we are looking forward to some consumer spending, inflation and manufacturing data from Japan. Although the numbers are worth watching, their impact on the currency market should be limited.
STRONG WEEK FOR THE CANADIAN, AUSTRALIAN AND NEW ZEALAND DOLLARS
Of all of the major currencies, the New Zealand, Australian and Canadian dollars have seen the sharpest gains against the US dollar this week.The kiwi is up more than 4.5 percent, the Aussie is up 3.5 percent while the Canadian dollar is up 2.17 percent. Their tie to commodities and their comparably high yields have helped to fuel the strong performance of these three currencies despite disappointing economic data from New Zealand. The current account widened in the second quarter due to a decline in exports while visitor arrivals plunged and credit card spending slowed.
In the week ahead, the market’s focus will be on the Canadian dollar as retail sales and consumer prices are due for release. Although there is no significant data due for release from Australia, New Zealand will be reporting their second quarter GDP figures.
USD/CAD:CURRENCY PAIR IN PLAY ON MONDAY
USD/CAD will the currency in play on Monday with Canadian retail sales due for release at 8:30AM ET or 12:30 GMT. Although it is the only country with any meaningful economic data at the start of the week, if US Treasury Secretary Paulson unveils a new rescue plan, that could also trigger some decent volatility in the US dollar.
Since the beginning of the month, the currency pair has been range trading, but it has just entered our sell-zone, which is established by Bollinger Bands. Friday’s sell-off stalled at a critical support level of 1.0465, which is established by the 50-day SMA, the 50% Fibonacci retracement of the 2007 sell off and the upper Bollinger Band. If USD/CAD manages to break that level again, we could see a move down to 1.0275. A close above 1.0550 would be needed to invalidate our bearish bias.
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This article has 20 comments:
The US is becoming a socialist state and its finance/dollar is in the doghouse supported by naked government manipulation before the elections. Sell the USD into any rallies and buy commodity currencies like the CAD, AUD for the long term.
Actually if McCain wins, I am thinking of moving up north to Canada.
Cautionary note to dollar bears: don't evaluate the $US in isolation, there are quite a few disreputable characters in the international currency ranks. This is no time for bravado and putting on large speculative positions.
As for the notion of a "V" shaped recovery ... it depends on how you look at it -- I actually don't see the letter "V" but instead an arrow that is pointing down (V) -
* www.financialpost.com/...
Not related - but for those who have followed Conrad Black - he weighs in today with an interesting article on the recent Wall Street goings on from his prison cell just outside of Disney World.
tinyurl.com/3s7zj6
Gold is so sentiment driven that it is useless as a barometer of real value of a currency. It has no utilitarian value so it is not tied to economic values at all. The survivalists are right. If you really want to hedge buy something that has durable utility.
There is no way I'd buy something as useless as gold.
I just don't see it.
You are presuming that other currencies/gold are now all-of-a sudden healthier because of what happened Friday. Really? I thought other central banks were pitching in to prop up the banks too. Buy gold? Yes gold has a short term up-trend, but it is still near its all-time high and has a long way to fall. I wouldn't be placing any big bets in this market.
andyn "The US is becoming a socialist state..."
No more than ususal. The government must intervene when faced with a run on the banks. Massive government intervention with taxpayer $$ to prevent a run on the banks has little-to-no effect on the level of US socialism.
When I look at the 8-year IWM chart and current P.E.s, I have to believe stocks have alot further to fall before any sustained rally.
Nothing has really changed, most stocks are down on the week, and cash is still king.
paper due to its riskier balance sheet. Can you blame them? An era has ended. What hath Wall Street wrought?
Have you traded currency through a $700 billion to $1 trillion government bail out?
Who has been in charge of Congress for the last two years?
In 2005, who was it that voiced concerns over Freddy/Fannie and who blocked those reforms?
Who are the former Freddie/Fannie execs, how much money did they make, and who are they now working for? (hint: they are working for one of the presidential candidates)
Which Congressmen/women, received sweet heart deals for personal gain, and or donations to their re-election campaigns from Freddie/Fannie and other financial & mortgage institutions?
dailymusings.spaces.li...
As far as socialism, goes, which vice presidential candidate, recently stated, that it is the "patriotic duty" to be taxed, and that money be given to the government for redistribution? (Hint: it wasn't Sarah Palin)
Citizens (sorry, we call them consumers) with students loans, debt, and 20%-30% credit card interest rate ) , can not barrow. If banks lend them any way, the cycle turn again with net results.
people lose homes due to Bidden Clinton vote for the Bankruptcy law, and banks end owning the land and homes again.
NEED to Revise the bankruptcy law again and students loans waiver law.