Weak Dollar Propping Up Everything Else

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Includes: DIA, GLD, OIL, SPY, TLT, UDN, USO, UUP
by: Jim Delaney

Keeping an eye on the new high, new low stats in Barron’s each week has become interesting in light of the swings the indices themselves make during the 5-day stretch bookended by Saturday and Sunday.

The latest figures for the NYSE were 684 new highs and 9 new lows. On an absolute basis the new highs number reached a new high for the time I have been watching it but the ratio of new highs to new lows (76:1 last week) was 127:1 during the week of 9/28 when there were 635 new highs and just 5 new lows.

Speaking of new highs and lows, it seems as if almost every currency in the world is making new highs against the Dollar as it makes new lows against them. The weaker dollar has created an attractive vehicle for Sovereigns and foreign corporates to issue debt, conducting the “carry trade” on a longer term basis than that usually seen in the foreign exchange markets.

For now the weak dollar appears to be the driver behind the rise in gold, oil and the U.S. Stock market but longer term the effects might not remain beneficial. Bill Gross was on CNBC recently and gave the following response when asked about the current state of the Greenback: “I think that’s part of the administration’s plan. It’s obviously not announced; the ‘strong dollar’ is always the policy, so to speak. One of the ways a country gets out from under its debt burden is to devalue.”

David Malpass, president of Encima Global LLC, wrote a piece in the Op/Ed section of the WSJ on Thursday taking issue with the weak dollar strategy and arguing against those who think such a play will eventually win manufacturing jobs saying: “In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages can create.”

David cites, Black Wednesday in Britain when the government was forced to withdraw from the European Exchange Rate Mechanism (NYSEARCA:ERM) in 1992, The Tequila Crisis when Mexico devalued the Peso in 1994 and Russia in 1999 when Boris Yeltsin was forced to wreck the ruble as examples of what happens when a currency is sinks too low versus its peers.

Ben Bernanke attempted to stop the slide on Thursday evening saying during a speech that the central bank was prepared to tighten “at some point” when the “economic recovery takes hold” and changed some of his other oft repeated verbiage saying the Fed would maintain “accommodative policies” instead of the usual “exceptionally low levels of federal funds” for “an extended period”.

To the extent that people spend entire careers dissecting “Fed Speak” these are recognizable changes in syntax but with the BLS announcing that 263,000 more people out of work per numbers released just a week ago and headline unemployment sniffing 10% not to mention all of the other employment related statistics that don’t appear close to turning around, it raises the question of just how long Ben’s script change can have an effect on the markets.

The immediate reaction in the bond market on Friday was an almost two and a half point drop in the price of the long bond and a point and an eighth on the ten year note pushing the yield on the latter to 3.382% on Friday from 3.25% on Thursday and a low of 3.18% on 10/1. It should be remembered that the 10-year is the benchmark for mortgage rates in the U.S. so a back up in yield raises re-fi rates and reduces the chances for underwater homeowners to get back on top of their financial situation.

With Uncle Sam issuing billions of new paper on a weekly basis a rise in rates also serves to increase debt service costs for a country struggling to get its fiscal house in order.

CDS levels on the U.S.A have been bouncing around just north of 20bps for a while now but hit their lowest level (20.5bps) on 9/30 of this year and since 9/23/2008 when they closed at the same 20.5bps mark.

The whole world looks a bit different a year hence and will probably look more so in 2010. Let’s hope the view doesn’t include Uncle Sam’s name on the list that includes those that devalued their currencies before us.

Enjoy the week.