Currencies Rally With Aid on the Way

If the equity market managed to rally despite news that 533k jobs were lost from the US economy last month, then Obama’s pledge to increase spending this weekend and the developments for the Big 3 automakers will only help. Risk appetite appears to be slowly returning to the markets with the low yielding US dollar and Japanese Yen losing ground to higher yielding currencies such as the Euro, Australian and New Zealand dollars.

Aid is on the Way

The market’s immunity to bad news suggests that everyone is tired of hearing the obvious, which is that the US economy is in bad shape and will worsen before it improves. It appears that all of the weakness in the first half of the 2009 is priced in and instead investors are latching onto the stimulus plans for hope that they will help to trigger recovery in the second half of 2009. This weekend, President-elect Barack Obama laid out his plan to create or preserve 2.5 million jobs . His focus is on infrastructure – upgrading public buildings to make them more energy efficient, building roads and highways and modernizing school buildings. He is hitting the ground running and is expected to announce a $500B to $700B stimulus plan in the first days of his administration.

At a time when uncertainty about the US economy is at elevated levels, the prospect of a major stimulus package and a decision on aid for the Big 3 automakers is helping to improve investor sentiment. The Big 3 automakers have dominated the headlines for the past few weeks and regardless of whether GM and Chrysler will be forced into bankruptcy, the markets will be relieved that there is a resolution.

Of course, there is still plenty of reasons to be skeptical about the rally in currencies and equities. The layoffs keep coming in as Dow Chemical announces an 11 percent reduction in their workforce, which translates into 5000 jobs. Bonus cuts, salary freezes and warnings about earnings have also become the norm.

But it is important to realize that equities and currencies have become extremely oversold in the past few weeks and the lack of any major US economic data until Thursday is helping to fuel the recovery. I think that we are witnessing a bear market rally and that we have yet to hit a long term bottom.

Here is the video of President-elect Barack Obama laying out key parts of Economic Recovery Plan:
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Dollar Rally Should Continue

Fresh concerns about the global economy have triggered sharp gains in the US dollar and the Japanese yen. Risk aversion continues to seep through the markets as the National Bureau of Economic Research finally admits that the US economy fell into recession in December 2007. The first trading day of the last month in the year has been exceptionally brutal with the Dow Jones Industrial Average falling more than 635 points or 7 percent. Even President Elect Barack Obama’s nomination of Hillary Clinton as Secretary of State has failed to help the markets.

Dollar Remains the Safe Haven Play, Bernanke Signals More Rate Cuts

There is no question that the meltdown in the equity market singlehandedly triggered the sell-off in the currency market today. Most people knew that the US economy was already in recession, but as reality hits with the official NBER announcement, investors bailed out of equities once again. In fact, we have seen a global flight to safety today with stock exchanges across Europe slipping more than 5 percent. The flight to safety has led to repatriation back into US dollars even though there is still more trouble ahead for the US economy. On day when manufacturing indexes across the globe hit decade to record lows, the US Federal Reserve was the only central bank to offer practical reassurance. Fed Chairman Ben Bernanke said in a speech today that further interest rate cuts are certainly feasible and even though their scope for conventional rate policy is limited, their other options include buying long term Treasuries or agency securities in substantial quantities.

Cyber Monday May Not Save the US Economy

Investors are looking to Cyber Monday in the hopes that retail sales may support the economy but even if consumers spent more this year than last, it is a result of discounts rather than underlying demand. Foot-traffic at the nation’s retailers on Black Friday was stronger than expected but many forecast that because the discounts were so deep this season, often reaching more than 50%, increased sales will not transfer into strong profits. The shopping event that transpired last Friday was more of an act of desperation by retailers than anything else. Industry groups, such as the National Retail Federation, note that weekend traffic fell-off significantly as buyers felt satisfied that they took advantage of all available discounts during Friday’s rush. In addition, more shoppers indicated that they were already done with their holiday shopping this year than last. Buyers also specified that gift purchases will be constrained to the younger audience, with older friends and family agreeing to forgo adult gifts. This type of behavior suggests that the momentum may be difficult to sustain for the remainder of the month.

Dollar Rally Should Continue
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EUR/JPY – Recession Trade

I have long said that EUR/JPY is one of my favorite recession trades. With the Eurozone in a recession and the need for the European Central Bank to step up to the plate and lower interest rates, the rate differential between the Euro and Japanese Yen will close and close rapidly. Furthermore, as US equities continue to tumble, EUR/JPY will follow suit.

But what I really like about this currency pair is that it is breaking out of a recent consolidation to the downside. As indicated by the chart below, the currency pair has entered the “Sell Zone” which I determine using Bollinger Bands. That level coincides with triangle support and the 23.6% Fibonacci retracement. As long as the currency pair does not rebound and take out close above today’s high of 120.47, I think it’s headed to 115 and maybe even lower.

Source: eSignal

Source: eSignal

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Dollar Soars as FOMC Minutes Trigger Liquidation

Despite false rallies in the currency market, I have stressed that there is no reason for the liquidation to be over. I warned that the currency and stock market rallies were a mirage rather than a bottom and now, the pessimistic tone of the FOMC minutes has forced another wave of liquidation.

Tuesday’s rebound in risk appetite was short-lived as the FOMC minutes revealed that the contraction in the US economy could last well into the summer of 2009.

In light of the 400 point drop in the Dow, the US dollar and Japanese Yen regained strength as repatriation and risk aversion continues to drive demand for the low yielders. The greenback’s recent strength can be most clearly seen in USD/CHF, which hit a fresh 14 month high today.

As we predicted, the FOMC minutes was the trigger for a major move in the currency market. However the moves that we have seen today need to be sustained before we can see a more meaningful breakout of the recent consolidation that we have seen across the currency market.

Something more powerful such as a decision on bailing out the automakers, next week’s GDP report or another surprising abysmal loss in the corporate or financial sector may be needed before we see new trends develop.

FOMC Minutes Confirms that More Rate Cuts Needed

The tone in the FOMC minutes, like the tone of Bernanke’s testimony yesterday was unmistakably dovish. The members of the monetary policy committee lowered their growth and inflation forecasts, talked about the downside risks to growth and how the contraction in the US economy will not temper until the middle 2009, at the earliest. Some members of the committee even openly discussed the need for further rate cuts, which confirms that rates will be lowered again in December. The Fed feels frustrated that interest rates are closing in on zero and acknowledged that it leaves them with little room to maneuver. Fed fund futures are pricing in a 50bp rate cut with a minor chance of a 75bp cut to 0.25 percent. If the Fed cuts interest rates by 50bp and the US economy fails to recover, their credibility will go out the window as the market questions their ability to tap other tools to stimulate the economy.

Automakers, Philly Fed and Leading Indicators

The Big 3 Automakers (General Motors, Ford and Chrysler) were on Capitol Hill today pleading for a bailout. Although a bailout of the automobile industry is inevitable in our opinion, it remains to be seen whether lawmakers will act quickly. The longer this drags out, the more pain it will cause for US equities.

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TIC Report Explains Dollar Rally – Top 5 Owners of US Treasuries

Despite the turmoil in the US financial markets, foreign demand for US securities remain robust, particularly since the Treasury’s International Capital flow report was for September, the month that Lehman collapsed.

TIC Report Explains Dollar Rally

Demand was particularly strong for US Treasuries and equities but foreigners dumped corporate bonds on the fear of default risk. As a testament to China’s rising economic power, they have now surpassed Japan as the largest holder of US debt. In September, increased repatriation led to a net sale of US securities by the Japanese while China accumulated a growing amount of US securities for the third consecutive month. The increase in foreign holdings of US debt helps to explains the dollar’s recent rally because despite higher issuance, demand for US Treasuries remains voracious.

Top 5 Owners of US Treasury Securities


Watch out for Paulson and Bernanke

The strong TIC report and the positive news from the tech sector is helping to fuel a recovery in Dow futures, which is driving the US dollar and Japanese Yen lower. We could see a recovery in carry trades today as long as Bernanke and Paulson don’t rain on the party when they testify on the government’s implementation of the $700B bailout plan before the House Financial Services Committee. This is a big risk since Paulson indicated yesterday that he will be leaving the clean up job for the new Administration. He does not plan on requesting the second half of the $700B bailout plan to leave firepower for Obama’s team. If Paulson continues to wash his hands of this mess, the market may begin to sell off once again, driving carry trades lower on the fear that nothing new will be implemented until Obama takes office. With 8 weeks to go before Bush leaves office, the current Administration is more focused on wrapping things up than starting new initiatives.

Source: Wall Street Journal

Source: Wall Street Journal

Higher Core Prices Will Not Stop the Fed From Easing Rates in December
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