Here’s an economic recap by Chris Gaffney of Everbank World Markets. Chris and his team provide solid economic analyses; with an emphasis on the impact to the currency markets, but also providing valuable information for anyone interested in economic affairs.
A shrinking US economy puts pressure on the US$…
Good day… Yesterday was a big day in St. Louis as President Obama came to visit on his 100th day in office. I can’t believe it has been 100 days since the inauguration. Time sure does fly! I’m sure Obama and the rest of his administration would like the calendar to move even faster as this recession will likely last through the end of 2009. While the government has thrown trillions of dollars at the markets in an attempt to turn them around, the key ingredient for recessionary cycles to reverse is time. There is now ‘quick fix’ for the problems we are in, and the policies the administration has begun will take time to have an impact on our shrinking economy. Obama said as much in his nationally televised press conference last night.
Speaking of shrinking economies, US GDP showed an even steeper contraction in the first quarter than that predicted by economists. US GDP fell 6.1% compared to the 6.3% fall during the last quarter of 2008. This drop confirms that we are now in the worst recession since the Great Depression. There report showed a record slump in inventories and further declines in housing. But another report released by the Commerce Department showed a surprising 2.2% gain in consumer spending in the first quarter, the most in two years. So we have consumers who increased their spending and confidence, while the US economy was contracting at near record pace.
Another report which didn’t get much press was the GDP Price Index and the Core PCE which are measures of price inflation. These numbers rose more than expected, with the GDP price index rising 2.9%, nearly doubling economists predictions of a 1.8% increase, and substantially higher than last quarters .5% rise. This sets up the possibility that we could see what many consider the worst case scenario, falling GDP with rising inflation (STAGFLATION). With inventories at very low levels, a slight increase in consumption can lead to a very quick rise in prices. But the Fed doesn’t seem to be bothered too much by that scenario, as they continue to focus on efforts to get the economy growing, with no apparent concern about inflation.
The Fed’s Open Market Committee voted unanimously yesterday to leave its target interest rate unchanged at between 0 and .25% (they really can’t go much lower!!). They also voted to continue to their purchases of long-term Treasuries and housing debt which they began last month. The FOMC statement said the contraction has slowed and the outlook “improved modestly” but the economy may “remain weak”. Job losses and a very tight credit market will likely inhibit consumer spending in the coming quarters.
As I said earlier, there was no mention whatsoever of an exit strategy on how the Fed plans to pull in the record amount of money supply it has unleashed on the economy. The Fed said they will continue to monetize the debt at an unbelievable pace: as much as $1.25 trillion of mortgage-backed securities, $200 billion of federal agency debt, and $300 billion of Treasuries. They are making these purchases in an attempt to keep interest rates at below market levels to fabricate a refinancing boom. While they have been somewhat successful in keeping rates lower than they would be under normal market conditions, these purchases are extremely inflationary and won’t be easily reversed. But the FOMC believes they will have plenty of time to worry about inflation and have decided to basically ignore it for now. Problem is, inflation can spike pretty quickly, and the FOMC will be hard pressed to raise interest rates just as the economy is starting to pull out of recession. I just don’t believe they will have the guts to be proactive with inflation, and will probably see a major spike in prices on the other side of this recession.
Inflationary concerns are at the forefront of the ECB as they prepare for next weeks policy meeting. ECB President Jean-Claude Trichet has imposed a gag order on council members as they argue over what to do next to rescue the European economy. Some members had been taking their cases to the media recently in an attempt to push the ECB into following the UK, US, and Japan down the quantitative easing path. But more conservative members don’t believe the ECB should use these untested methods, and are worried about the eventual inflationary impact of them. The ECB cut rates less than expected in April, and pushed a decision to use other methods off to next week’s meeting. Germany’s Axel Weber wants to make 1% the floor for the benchmark rates, and is against buying debt to pump additional money into the economy, while other council members want to begin asset purchases to force rates lower.
Data released this morning show Europe’s unemployment rate rose to the highest in more than three years, and inflation held at a record low, which will increase pressure for the ECB to continue to cut rates. The March unemployment rate jumped to 8.9% in the Euro area, and inflation held steady at .6% in April. Other reports released this week suggested confidence in Europe is stabilizing which could counter some of the pressure to take additional measures. Chuck will bring you the details of the ECB meeting, which will occur a week from today.
The dollar sold off on safe haven reversals, but then moved back up in European trading. So after a bit of a roller coaster ride, we are pretty much right where we started yesterday morning. But the overall market sentiment seems to be shifting back to dollar negative. Two separate reports released by currency trading desks yesterday revised their currency forecasts down for the US$. Bank of America – Merrill Lynch revised their forecasts for the dollar, yen, euro, and pound on the ‘rising probability’ the global recession has passed its lowest point. Their report stated the euro would recover faster than previously predicted as the global economy turns. A separate report by Citigroup said the dollar would fall if/when the 10 year Treasury note yields rise above 3.06%. Technical analysts at Citigroup wrote that past trading patterns look like they are repeating. “Buying the dollar and US Treasuries was the trade of choice toward the end of 2008 and is now unraveling,” they said.
Global deleveraging pushed investors back into US$, but as the global economy recovers (led by an increase in consumption in China), investors will move these funds out of this safe haven. Yield differentials will again determine investment direction, and growing economies will be able to attract more speculative capital. The US$, which has benefitted from the global downturn, will be sold. In order to protect your portfolio, investors should have some exposure to the currencies and metals.
One currency which has turned in one of the best performances vs. the US$ this week has been the Canadian dollar. The loonie touched the strongest level in two weeks on a move up in the price of oil. Equity markets are up, as investors have become much more confident regarding a global turn around. This confidence has carried over to the commodity markets, where oil and some of the industrial metals have been rising again. Canada relies on shipments of raw materials including oil, natural gas, copper, and lumber for more than half of its export revenues.
A report released by TD Securities, a large Canadian trading desk, predicted the Canadian dollar would appreciate by as much as 14 percent by November if it breaks through a key technical level. If the US dollar breaks below 1.1764 CAD$/$ (or above .85 UScents/CAD$) the upside opens up hugely over the next few months. The report puts a target of 1.04 CAD$/US$ (or .9615 US$/CAD$) for the loonie, a 14% increase from today’s levels.
As I touched on above, the commodity currencies turned in one of their best performances in weeks as the price of oil shot back above $50. Both Norway’s krone and the Australian dollar rallied along with the Canadian dollar. The AUD$ actually rose to the highest level in more than six months against the US$. The Norwegian krone, Australian dollar, and Canadian dollar are three of the best four currencies vs. the US$ on a YTD basis. The top performer vs. the US$ in 2009 has been the South African Rand, but recent rate cuts there may start eating into its recent strength.
South Africa cut its benchmark rate a full percentage point, the fourth reduction since December to help spur their economy. New Zealand’s central bank also cut rates to a record low yesterday. Reserve Bank Governor Alan Bollard reduced the overnight rate by 50 basis points to counter the nation’s worst recession in more than three decades. He indicated that rates may go lower, and will stay down for the foreseeable future. The kiwi sold off after the announcement.
Good economic news out of Japan has been rare, so yesterdays report that Japan’s factory output rose for the first time in six months was a surprise. And even more surprising was the fact that the pace of the output rise was nearly double that predicted by economists. Factory production climbed 1.6% in March from February, when it dropped 9.4%. In a separate report, the Bank of Japan said the world’s second largest economy will resume growth in 2010 after shrinking 3.1% this fiscal year. But I still caution investors regarding investments into the yen. The Japanese yen benefitted from the reversal of the carry trade, but global markets seem to be substantially less leveraged than before. The Japanese yen is not going to be able to benefit from another large push by additional deleveraging.
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