David Coffin co-wrote this article.
So, it comes to this. The Fed announced the most anticipated rate cut in history; though some didn’t expect 75-100 bps based on the ecstasy on Wall Street after the announcement. This move brings the Fed to the end of Stage One in its battle to save the world from the aftereffects of the credit bubble. The Fed can’t cut rates any further and, based on where short term Treasuries have been trading lately, this move just made official what the market had already priced in. A big upward move in the main US equity indices notwithstanding, this was hardly a shocker.
The other group that reacted with equal vigor was the currency traders. With the moves the Euro and Yen have had the past couple of weeks, it would not have been a surprise to see a bit of consolidation in the wake of the latest Fed rate cut. It wasn’t to be however. Both currencies had 2% plus moves immediately after and both have moved higher still against the Dollar since. The chart below shows just how strong the downward move in the dollar index has been. It’s fallen off a cliff. We can’t see how the most rabid Dollar bulls could look at this chart and see an uptrend. For now at least the Dollar surge is over.
We have been expecting this move for a couple of months now. We have said repeatedly the Dollar would roll over once the market terrors crested (if they have) and that we expect the Yen to move as high as 80 to the Dollar by the time all the carry trades were unwound. We don’t imagine many in Euroland or Japan are thrilled about these currency moves but they had to happen.
This is not “just” about interest rate differentials. Most of the rise in the Dollar’s value can be attributed to fear buying in the Treasury market, deleveraging and asset repatriation trades by funds and hedge funds. It’s impossible to know how much deleveraging is to come since so much of it originates in the shadow banking system. Large Q4 redemptions for hedge funds could lead to more deleveraging trades though the worst is probably over until we get into January at least. The Obama early honeymoon (stag? bachelor party?) rally is also helping; a little risk appetite is moving money out of $USD and forcing some to take a harder look at the Dollar security blanket trade.
Let’s face it; aside from fear buying, the greenback has little to recommend it. The interest rate is non-existent. Other forward looking metrics favored by currency traders like current account and government deficits are just ugly and likely to get worse. There are still plenty of talking heads that expect the US to lead the world out of recession which could argue for a stronger currency. We don’t. As we’ve stated before we think it's probable the US will be one of the last major economies to exit this recession, not the first. The US consumer did the heavy lifting last few times but has no means to repeat it. Not pretty and we’d be pleased to be wrong about that call but we don’t see a driver to move the US ahead of the pack, even assuming a humongous Obama stimulus package.
We noted in a couple of recent issues that the financing environment for the US Treasury has never been better. We’re surprised not to see more Treasury issues. No one has any illusions that the money won’t get spent so the Treasury should sell debt while the selling is good. Once they have filled up the coffers it’s really not in the interest of the US to have a strong currency. They might as well make exports cheaper, imports dearer and discount future debt payments. The tricky part will be avoiding a race to the bottom by other fiat currencies, but that’s next year’s problem.
Now that Stage One is complete, the Fed moves to Stage Two: Quantitative Easing under the guise of a plethora of new programs being spun by Bernanke and Paulson. In effect, it will be brute force buying in the credit markets, bidding up corporate and mortgage bonds and swapping shiny new Fed and Treasury securities for no-bid toxic junk. In theory, enough of this buying will force down yields on non Treasury and Agency credits and encourage lenders to, well, lend. Combined with the Obama stimulus plan this should work – eventually. When “eventually” comes around we’re not sure. Banks are still hoarding cash and will continue to do so for a while. Hopefully the credit markets thaw as we head towards the middle of 2009. Interbank rates have eased significantly since October but it will take some confidence building for that to be passed on.
All these rescue programs are generating a lot of press from gold followers fretting about hyper inflation. We don’t see that for a couple of reasons. Most importantly, money being created by the Fed is just replacing private funds that have gone to “money heaven”. Additionally, most of these programs are not inflating the money supply – yet.
The numbers for overall commitments are scary at $8 trillion plus but its unknown how much of this will be monetized. We suspect a lot of it will be, but not until the process is farther along. Purists will point out that inflation is a monetary phenomenon and that the money supply is already growing rapidly. True, but most people couldn’t care less. They react to CPI not money supply numbers. Inflation at a consumer level is still falling, though a lot of that is thanks to tanking oil prices. Like the race to the bottom for fiat currencies inflation is next year’s problem – if we’re lucky.
The good news is that all this bad news has had a predictable (and predicted here) effect on the price of gold. After last month's head fake, gold bottomed higher than October and is moving up again against the wilting Dollar. It has now put in a higher low, a higher high, blown through its 50 moving average and is closing in on the 200 day. It is also close to breaking out from a longer term down trending channel. We would expect another round of short covering if that break out happens, which is only $10-15 above yesterday’s close. A move through those levels could generate a run towards October’s highs in the $925 range.
After a muted response in the past few weeks, silver has also finally started its own climb. It continues to be dogged by its “industrial” side but has been generating percentage price moves about twice the size of gold’s (in both directions) for the past few sessions as was common earlier in this bull market. Silver has also broken through its 50 day moving average and seems to be forming a new uptrend though it has to move up much farther than gold to get near its highs earlier this year. Silver can move faster than gold but the general negativity means it’s likely to be a follower for a while yet. It won’t keep moving unless gold does.
So where do we go from here? The fall in the dollar has been extreme and it was looking oversold by the end of today’s session. That might generate some consolidation; with the most likely candidate for support being the Euro. Europeans cannot be happy about a Euro above $1.40. Unlike Japan, they might be able to do something about it.
The ECB has been sounding hawkish on interest rates but the political pressure to cut rates again will mount quickly now. The ECB has never been pliant in the past, so grumbling by politicos may not work. Medium term we see no reason the Dollar should not fall further unless the US suddenly generates some much improved economic statistics. Gold and especially silver do not look overbought. They could flatten but it does not look like there will be a big pullback right away short of a surprise ECB rate cut though they will consolidate if the Dollar does. This is still very much an “anti-dollar “story.
The market is supporting a relatively small number of success stories, which is an improvement, but those are safer for now than cheaper seeming market orphans. As always, the idea is not to chase the ones you like but get them on weak days,
There is about a week left for tax loss selling. While the speculative indices have not seen much of a gain there has been a lot more volume. Again, it’s been selective but there are a number of companies that are seeing buyers arrive to take large crosses and put a floor, however low, under a number of stocks. That is a good enough start for now and a sign there is some life left yet in a sector many have written off.