Dollar Tanks as Jobless Claims Signal 75bp Rate Cut from Fed

The US dollar is tanking as jobless claims rise by the largest amount since November 1982, 26 years ago. As I have suspected, it is the 1980s all over again.

This confirms that the 533k drop in non-farm payrolls last month will not be the bottom in the labor market. When claims first hit 573k in January of 1982, non-farm payrolls dropped by -327k. It rebounded significantly the next month (-6k), but that was only precursor to another 10 consecutive months of job losses with non-farm payrolls revisiting the -300k levels in July (NFP in July 1982 was -343k). These jobless claims numbers reflect the massive layoffs that we have heard in the past weeks from companies like AT&T, Viacom and Sony. Continuing claims hit 4.429 million, the highest since 1982.

The widening of the trade deficit leads us to believe that GDP will take a big dive in the fourth quarter. The Treasury market is already pricing in the possibility of deflation and depression with yields in zero to negative territory for the first time since the Great Depression and incoming data supports that thesis.

The weekly jobless claims number will add pressure on the Federal Reserve to cut interest rates by 75bp next Tuesday. Fed Fund futures are already pricing in a 100 percent chance of a 75bp rate cut from the Federal Reserve next week. This would take US rates to 0.25%, making the US dollar the lowest yielding currency in the developed world.

If the Fed takes interest rates to zero, we could see USD/JPY fall to 13 years lows and the Euro to return to 1.35.

Even though volatility in the currency market has compressed since October and November, the Federal Reserve’s next interest rate decision is a major event risk because interest rates will be taken to historically low levels. Not only are the Fed expected to take interest rates to the lowest level this generation has ever seen but they have to figure out how to effectively signal their intentions of taking US interest rates to zero without completely spooking the markets. This will be a difficult balance to walk and one that could easily lead to an expansion in volatility in the currency market.
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Is the Currency and Equity Rally a Mirage?

In every major bear market, there are relief rallies and that is what we have seen today. The Dow Jones Industrial Average dropped more than 300 points during the US trading session before reversing violently to end the day up more than 550 points. The major turnaround in equities has forced the US dollar to give back its gains.

However as much as I would love to see the global unwind come to an end, the continued weakness in US economic data makes me really skeptical of this rally. Nothing is behind the move other than short covering. Therefore this could be more of mirage than a bottom for currencies and equities.

Ask Your Neighbor About Retail Sales

Jobless claims rose 516k last week to the highest level since September 2001 and it has a direct correlation with consumer spending. Retail sales are expected to contract for the fourth consecutive month. The recent bankruptcies and profit warnings confirms that US retailers are already struggling. Both ISCS and SpendingPulse reported a sharp decline in sales while various independent studies across the nation report that consumers are cutting back. The recent drop in oil prices means that gasoline receipts will fall as well. The average price of a gallon of gasoline has fallen close to 50 percent from its summer highs. We don’t expect consumer spending to recover until well after the holiday shopping season. Just ask your neighbor and he will probably tell you that he is cutting back his spending as well.

No V Shaped Recovery
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The 3Ps Push the Dollar Higher

The US dollar continues to recover this morning on the aftermath of the 3Ps – Paulson, Plosser and price of oil. Oil prices are trading on the $125 handle and since last Monday they have fallen more than 14 percent. If oil prices reach $100 a barrel, half of the Fed’s problems would be solved; Consumers would become more liberal with their spending while businesses would become more optimistic.

As for Plosser and Paulson, the Fed President called for interest rates to be increased sooner rather than later, reminding the traders that the Fed still has their eyes on a rate hike.

US Treasury Secretary Paulson was confident that Congress would approve his housing rescue plan this week and so far they are moving forward as planned, with some adjustments.

Paulson proposed increasing Fannie and Freddie’s credit line with the Treasury and permission to buy stock in the mortgage giants. The deal that is likely to come out of the House and Senate would permit the government to inject billions of dollars in Fannie and Freddie and to insure up to $300B in refinanced mortgages. The plan is up for vote at the House of Representatives today.

Meanwhile EUR/JPY has hit another record high and is trading within a whisker of 170. Here’s my explanation of why EUR/JPY has performed so well over the next few months.

Finally, keep an eye on the Beige Book report of business activity which will tell us how the US economy is faring.

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