The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
The Forex Week Ahead
09/14/2009 12:09 pm EST
Irrationality Dominates and the USD Suffers
Headlines dominated last week and the news was deemed decidedly US dollar negative. Calls from the UN for a new global currency to replace the dollar dovetailed with musings from a top member of the Chinese hierarchy that the country is alarmed by US money printing. If that wasn't enough, President Obama asked the Senate to raise the federal debt limit to $12.1 trillion by mid-October, raising more deficit concerns, and the World Economic Forum's global competitiveness report showed Switzerland knocking the US from the position of world's most competitive economy. In broad terms and as we write, the US dollar has given up -1.8% on the week.
There was nothing really new in the dollar-bashing news flow, but reminding the market about dollar doldrums as trading comes back in earnest after the summer lull elicited a wave of USD selling. EUR/USD added 1.9% towards the 1.4570 area at last look after taking out several option barriers on the way up. We still view the 1.4621 level as key on a daily closing basis. This is a 61.8% retracement of the drop from the 1.6038 all-time high to the 1.2330 low back in October 2008. Cable witnessed similar gains of 1.7% all the way up towards the 1.6670 zone. Some of the strength here was helped by the Bank of England's decision to leave their asset purchase program unchanged.
We continue to view drops in the US dollar as good buying opportunities and remain extremely cautious about the return to risk taking. US equities continued to extend gains and the S&P 500 tacked on another 2.5%, coming within pennies of the 1050 mark. This was despite data that suggest the recovery is setting up to look rather lackluster. Early in the week, we saw a colossal -$21.6 billion drop in consumer credit. However, outstanding credit (excluding real estate) is now down a mere -$109 billion from the all-time high. And while consumer credit outstanding as a share of annual disposable income has fallen to 22.7% from a high of 24.4%, it is still a far cry away from a more normal 16% to 18% range that dominated for three decades before the secular—and clearly unsustainable—credit expansion of the last 15 years. Heading back towards the top of that more normal range implies a contraction in credit of about -$550 billion. This is roughly 5% of annual consumer spending and suggests that should the consumer decide to de-lever in a significant way, corporate earnings will suffer.
The other telling report was the Fed's latest Beige Book. The headlines were less rosy than the market was looking for. In sum, the Fed noted that most districts reported tight credit standards, downward pressure on home prices, weak labor markets, and flat retail sales. Keep in mind that this report was written for a month when "cash for clunkers" skewed much of the on-the-ground data upwards. So equities continue to make new highs even as one of the most complete diagnoses of the US economy suggests the consumer remains down in the dumps. We think that once the sugar high from the government-subsidized "better data" (housing, confidence, autos) passes, equity marts will have nowhere to go but down. Correlations we have witnessed all year will likely continue to play out and we would expect any short-term correction lower in risk to land a big blow to EUR and the commodity currencies. The USD selling looks extremely overdone and is merely opening up a great buying opportunity, in our view.
US Bond Market Not Flashing Risk Taking
For all the talk about global diversification away from the US dollar, this week's Treasury note auctions proved that demand for the paper remains extremely robust. The most telling of all was the 30-year bond auction, which was oversubscribed by 2.92 times and saw foreigners take about 47% of the offering. That 2.92 bid/cover was the best in nearly two years and suggests investors remain confident—on a long-term basis—that the US will pay its debts. This coupled with that horrid China exports number, which sank to a -23.4% annual rate in August from -23.0% prior, suggests that the dollar's demise is far from around the corner. China will continue to be hard-pressed to bash the buck given that it holds nearly $800 billion in Treasury securities and that it depends on the US consumer to support a large chunk of their export market.
On the back of the strong auctions, the ten-year note yield sank to the lowest level since mid-July, printing a low this week at 3.27%. The fact that investors continue to buy these safe-haven assets hand over fist in the face of an unprecedented equity market rally makes the sustainability of these stock market gains suspect. The yen crosses seem to be taking their cue from yields, with EUR/JPY dipping from 133.00 to 131.70 this week, while USD/JPY has dropped from 93.00 to 90.50 commensurately. We believe it is these asset classes that have the story right and that the riskier EUR and commodity currency trades are due for a correction.
Gold Push Higher Has No Legs
The story has not changed in the latest gold run up. The world's largest gold producer has ostensibly undertaken massive purchases in order to close out its hedges, and this has kept XAU/USD better bid all week. It appears that the company's trade is going against them, so they have to bail on their hedges by buying back gold. This flow gave the precious metal ample room to move above the $1000 mark and all the way up to a weekly high of $1012. We would be cautious about the sustainability of this sharp rally, however, as the metal has suffered multiple failures on moves above the $1000 mark. In fact, gold has only managed two daily closes above $1000 ever. Not sure that is a well-advertised fact.
The gold bugs will tell you that money printing and Keynesian economics of the Obama administration will drive hyper-inflation and that gold is the only way to defend against this inevitability. While they may ultimately be proven right— indeed no government has ever expanded fiscal and monetary stimulus to the extent the US has and not seen inflationary repercussions—we think it is early still for the inflation debate. The fact that Treasury yields have actually fallen in the face of the +5% September rally in gold should give the bulls some pause.
Until inflation fears are confirmed by the bond market via sharply higher interest rates, we would remain sellers of rallies in the precious metal. The air above $1000 remains extremely thin and the $1000-$1015 area still looks like an attractive selling zone. For the range players, a dip into $980-$970 looks like a good short-term scoop as well. For those who believe the commodity rally is still in its infancy stages, we prefer buying silver and selling gold and think that the ratio between the two metals still has another -16% of downside. That XAU/XAG ratio has come crashing down from 71.7 to 59.4 since we recommended this trade back in mid-July, and we believe the path of least resistance remains one towards the 50 area. This pair trade only needs silver to outperform gold on a percentage-change basis. So silver needs to fall by less than gold in an environment where precious metals are slipping, or rise by more than gold when both are rising.
By Brian Dolan, chief currency strategist, FOREX.com
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