The US dollar appears to be unfazed by this morning’s mixed economic data. An improvement in consumer confidence has failed to help the dollar while the weaker news has pretty much been baked into the markets.
Christmas and New Years week is a time when traders are more focused on seeing family than making profits. It is probably truer this year than most because of the sharp volatility in the financial markets and the deep losses endured by most investors.
Third quarter GDP remained unrevised at -0.5 percent even though personal consumption slipped and core prices eased. Investors are more worried about the Q4 numbers than the Q3. The global recession and the stronger dollar could take a big bite out corporate earnings and growth.
The housing market also remains weak with new home sales falling for the fourth consecutive month and existing home sales falling by the largest amount on record. Sharp discounts on new homes is helping to slow the pace of falling demand.
The one piece of good news that we did see this morning was consumer confidence which was revised upwards in the month of December. Given that almost everyone knows someone that has been laid off, the price of gasoline is the only reason to cheer this holiday season. Prices at the pump have fallen close to 60 percent from its summer highs. For drivers, lower gas prices is like a tax cut. At a time when salaries are being frozen and bonuses are being reduced, a tax cut in the form of lower gasoline prices is welcomed with open arms.
The Federal Reserve cut interest rates by 75bp to a range of 0 to 0.25 percent, the lowest level that this generation has ever seen.
In our FOMC preview, we talked about how the Fed may consider adopting a BoJ style rate cut that takes interest rates somewhere between 0.25 and 0 percent. Although that was exactly what we saw today, we expected it to happen in March and not December. The Fed has taken another page out of the Bank of Japan’s book and will continue to follow in the footsteps of the Japanese central bank as they formally adopt Quantitative Easing even though they refuse to use those words explicitly.
It is no surprise to see the US dollar selling off aggressively as it is now the lowest yielding G10 currency. This was the right move for a central bank that wants to be proactive and no longer just reactive. There is no point for the Federal Reserve to play games anymore by denying what is already being priced into the markets. Cutting interest rates to 0.25 percent was inevitable and they rather deliver this stimulus now than later. Fed funds were trading as low as 0.15 percent going into the FOMC meeting. The Federal Reserve expects to keep interest rates at “exceptionally low levels for some time,” and to employ all available tools going forward including the purchase of long term Treasuries. In other words, the Federal Reserve is telling us that they are formally moving to Plan B, which is Quantitative Easing.
There is no question now that the Federal Reserve is the most aggressive central bank. Since 2007, they have cut interest rates by 500bp and since the beginning of year, they have cut by 325bp. With the economic outlook weakening and the financial markets remaining quite restrained, the Fed wanted to over rather than under deliver. This morning’s consumer price numbers also raises the risk of deflation, which may have pushed the Federal Reserve to make the larger move. The Fed did not indicate in the FOMC statement whether zero interest rates are still on the table, but an interest rate of 0.25 percent is just as bad.
The US dollar has embarked on a new downtrend and today’s interest rate decision only cements that. We expect more dollar weakness in the first half of 2009. There is a reasonable chance that USD/JPY could fall to 85 and the EUR/USD could break 1.43. And of course, I still love the AUD/USD trade.
Comparing the FOMC Statements:
FOMC Statement December 16, 2008
US retail sales and producer prices were basically in line with expectations but that does not undermine the fact that the data was very weak and confirms that the Federal Reserve will be cutting interest rates by 75bp next week. USD/JPY hit a 13 year low last night after news that the automaker bailout plan is not going happen before the new year. Everyone had hoped that the automaker saga would come to an end, but lawmakers are not letting that happen. On Wednesday, I said that USD/JPY could hit to a new 13 year. At that time, the currency pair was trading at 92.50-93.00. The possibility of the US taking interest rates below Japanese levels should keep the US dollar soft going into the Fed interest rate decision on Tuesday.
Consumer spending fell for the fifth month in a row while producer prices dropped for the second straight month. The two biggest inputs into GDP are retail sales and trade. Consumers cut back spending more aggressively in October and November which suggests that GDP growth could take a big dive in the fourth quarter, especially with the widening of the trade deficit.
GDP Could Contract by 4 to 6% in Q4
GDP could decline as much as 4 to 6 percent in Q4, which would be the largest contraction in growth since the 1980s. In the first quarter of 1982, GDP fell -6.4 percent. A 4 to 6 percent drop in GDP would not be out of the ordinary given the current conditions in the US economy. In the fourth quarter of 1990, GDP contracted by 3 percent and in the first quarter of 1991, it contracted by 2 percent. The currrent recession is worse than the one the US economy experienced in the 1990s, so a contraction in growth exceeding 3 percent would actually be expected.
The biggest drop in consumer spending came from gasoline station receipts. Prices at the pump have fallen more than 50 percent since the summer and gas stations are suffering as a result. The only silver lining in the retail sales report is the fact that not every sector saw slower sales. Electronics and sporting goods were in demand but this rebound after at least 4 consecutive months of softer spending is probably related to Black Friday sales.
BTW: EUR/GBP is at the brink of hitting 90 cents – a move that I called on Dec 8
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.
We are inching closer to a formal bailout plan for the Big 3 automakers and as previously suggested, regardless of the final outcome, the markets will cheer an end to the drawn out drama. The rally in equities this morning have driven major currencies higher against the US dollar and Japanese Yen, but it remains to be seen whether the improvement in investor sentiment will last. We are walking into a lot of potentially weak economic data on Thursday and Friday that could serve as a harsh reminder of the problems that the US economy faces. The PPI and retail sales figures should resurrect concerns that deflation and depression will hit the US.
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. Fed Fund futures are 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. Although the greenback has remained weak against the Japanese Yen, if the Fed takes interest rates to zero, we could see the dollar fall to 13 year lows against the Japanese Yen.