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Forex Research - How Does the US Dollar Perform in a Recession?

How Does the US Dollar Perform in a Recession? Last Updated 12/2/2008 6:21:38 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

EUR/CAD ( +170 pips or +1.09%)

EUR/CHF ( +134 pips or +0.88%)

EUR/JPY  ( +88 pips or +0.75%)

THE STORIES IN THE CURRENCY MARKET

  • USD: How Does the US Dollar Perform in a Recession?
  • EUR: Bucks the Trend Despite Weaker Data
  • GBP: All PMI Reports are at Record Lows
  • AUD: Service PMI Shrinks for Eighth Consecutive Month
  • CAD: Oil Prices at 3 Year Lows
  • NZD: Trails Equities Higher
  • JPY: BoJ Accepts Corporate Debt as Collateral

EXPECTATIONS FOR UPCOMING FED MEETINGS

 

** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

US DOLLAR: HOW DOES THE DOLLAR PERFORM IN A RECESSION?

It is a challenging week for the financial markets and today’s recovery in equities is characteristic of a bear market rally which is why the dollar managed to hold onto its gains against every major currency except for the Euro. As the only currency that appreciated more than 20 pips against the US dollar, there is little to explain the Euro’s strength other than a clear decoupling from commodities. Since the beginning of the year there has been a 70% positive correlation between the EUR/USD and oil prices but now we are seeing the correlation break down as oil prices hit a 3 year low.

How Does the US Dollar Perform in a Recession?

Counting the current one, there has been 3 recessions in the past 30 years. In each of those recessions, the dollar weakened in the first six months of a recession, then gained strength in the next six. Twelve months into this current recession, we see this pattern in the dollar repeated. The next question to ask is whether there is a pattern in the way the dollar performs in the second year of a recession. Taking a look at how the dollar traded in 2001, the 1990s and the 1980s, we see no consistent trend but that is only because the 1990 and 2001 recession only lasted 8 months. The current recession can only be compared to the one in the 1980s and based upon how the dollar performed then, we could expect a near term top in the US dollar in the first half of 2009. In 1981, halfway through the 2 year long recession, the US dollar index plunged more than 7.5 percent before recovering and taking off once again. We could see that pattern repeated in 2009.

Trouble for Automakers

The big focus in the financial markets today was automakers. The Big 3 are back in Washington presenting their plans to Congress in the hopes of securing $25 billion in federal loans. Their financial situations have become more severe since their last visit and perhaps today’s monthly sales figures will sway some members of Congress. General Motors, Ford and Chrysler all reported that sales fell at least 30 percent in the month of November with Chrysler being hit the hardest as US car sales dropped 47% last month. These steep declines will push these automakers closer to bankruptcy, leaving Congress with a tough decision. If Washington does not grant the $25B loan to the Big 3 automakers, the announcement could send equities below its five year lows. This would weigh heavily on the entire currency market and poses big risks for the US economy which is why we believe that it is not a gamble that Congress will not take. This may be part of the reason why US equities recovered after having turned negative at one point following the release of the vehicle sales figures.

Traders Shrug Off More Layoffs as Fed Extends Emergency Loan Programs

With non-farm payrolls on the calendar this week, traders should be particularly sensitive to any reports pertaining to health of the labor market. JPMorgan announced this morning that they will be laying off 9,200 jobs at Washington Mutual Bank. There are also talks that 10,000 jobs could be cut from Bank of America, mostly from Merrill Lynch. The labor market is in bad shape and likely to get worse even if we do see a blowout number on Friday. The most important leading indicators for non-farm payrolls are due for release tomorrow, which are the Challenger job cuts report, the ADP employment change and service sector ISM. If we see all around weak numbers, then it is almost certain that non-farm payrolls fell by more than 300k last month. The stock market however did not give the layoff announcements a second thought as the Federal Reserve continues to take steps to mitigate a deeper credit crisis. They extended 3 of their emergency loan programs by 3 months as the credit markets remain tight. The Beige Book report is also due for release tomorrow and we expect the Fed districts to vocally confirm what the economic data has been showing which is that the US economy is in trouble.

EUR/USD: BUCKS THE TREND DESPITE WEAKER DATA

The Euro bucked the trend today by gaining strength against the US dollar today despite weaker economic data. Eurozone producer prices plunged 0.8 percent, the largest drop in 22 years. The decline in inflationary pressures should give the European Central Bank the flexibility to make a larger interest rate cut on Thursday but it remains to be seen whether the ECB will make a 75 versus 50bp rate cut. Economists are also split with most calling for a smaller move. Anything larger than a half point cut would be biggest for the central bank since their inception in 1999. Eurozone retail sales and the final figures for service sector PMI are due for release tomorrow. Given the sharp drop in German retail sales, the regional index should see a substantial decline as well. Switzerland also saw a sharp decline in consumer prices, which opens the door for the Swiss National Bank to take interest rates to zero. The resilience of the Euro suggests that if equities extend their gains on Wednesday, the Euro could outperform its peers.

GBP/USD: ALL PMI REPORTS ARE AT RECORD LOWS

The British pound remains weak as the United Kingdom continues to report that their economic data has hit record lows. Yesterday it was the manufacturing PMI index and today it is construction sector PMI, which slipped to 31.8 from 35.1. Tomorrow we are expecting service sector PMI which is already at a record low. All three of the PMI reports are in contractionary territory reflecting the dire situation of the UK economy. The Bank of England is expected to cut interest rates by 100bp on Thursday and the price action of the British pound suggests that traders are positioning for that. The central bank has been relatively muted about the weakness of the currency. There is a good reason for that since its depreciation helps to cushion the UK economy. Australia is a perfect example. A lot of exporters and multinational companies in Australia have raised their earnings forecast thanks entirely to the weakness of the Australian dollar. Combined with the proactiveness of the central bank, we expect the UK economies to be one of the first to turn around when the dust settles.

AUD/USD: SERVICE PMI SHRINKS FOR THE EIGHTH STRAIGHT MONTH

The rally in US equities helped to take the Australian, New Zealand and Canadian dollars higher despite a larger than expected interest rate cut from the Reserve Bank of Australia. The RBA unexpectedly cut its interest rates by 100 basis points to 4.25 percent. Since the beginning of the year, they have now cut interest rates by 275bp to a six and a half year low. Like other central banks around the world, monetary officials are concerned about recession even though Australian economic data has not been filled with the same disappointments that we have seen in other parts of the world. Retail sales actually increased 0.2 percent in the month of October. Both retail sales and the trade balance improved in the third quarter, paving the way for a stronger Q3 GDP report. The RBA however is looking ahead at numbers like the service PMI that came out this afternoon. The index shrank for the eighth month, leading some traders to believe that more rate cuts and economic stimulus will be needed. While there were no releases from New Zealand and Canada, the Canadian dollar remained under pressure as oil prices slipped to 3 year lows.

USD/JPY: BOJ ACCEPTS CORPORATE DEBT AS COLLATERAL

Some but not all of the Japanese Yen crosses trailed equities higher today. The intraday volatility in the financial markets has kept many investors risk averse. Carry trades or the Japanese Yen crosses never do well when volatility is high, which may be part of the reason why pairs like USD/JPY and CAD/JPY failed to join in the rally. In fact, the move in most of the yen pairs has been modest with only EUR/JPY seeing any material gains. The Bank of Japan left interest rates unchanged at their emergency meeting last night but they decided to accept corporate debt as collateral form banks. This step is aimed at freeing up capital or risk from banks so that they would be more willing to lend to consumers.

GBP/USD: Currency in Play for the Next 24 Hours

The currency in play for the upcoming 24 hours will be GBP/USD. We are expecting the release of UK PMI at 9:30AM GMT or 4:30AM EST. From the U.S., we expect the ISM Non-Manufacturing Component at 15:00GMT or 10:00AM EST.

With a heavy sell-off in the “cable” for past couple of days, the pair is on the verge of entering the sell-zone according to our Bollinger Bands. The selling was prompted as the pair hit the 23.6% retracement of September 25th high and November 13th low. The bottom of 1st Deviation of the Bollinger Bands is originating at the price of 1.4860, upon the break of which the pair is going to enter the sell zone. Due to the emergence of an uprising triangle, short term support will be at the price of 1.4775. If the pair breaks that level, it could experience a moderate sell off to the 1.4560 level which is a 6 year low. The pattern will be negated if the price breaks 1.5070, the 20 day SMA and the high for today. As both countries’ economic indicators continue to show signs of weakness, any positive data could drive the price in either direction.

 

About The Author

Lien has extensive knowledge within the interbank market, particularly in trading spot FX and options. She has written for numerous publications, is frequently quoted on financial media outlets, and is the author of several books, including Millionaire Traders. Read more >>

DISCLAIMER: This forum and the information provided here should not be relied upon as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. This forum and its information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision based upon this forum or any information contained within. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Kathy will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Kathy do not render investment, legal, accounting, tax or other professional advice. If such advice is sought, or other expert assistance is required, the services of a competent professional should be sought.

 

 

 

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  • POTENTIAL PRICE RISK: HIGH Tue-- 08:30 GMT GB- CPI top tier confirmation of Inflation.

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  • POTENTIAL PRICE RISK: Medium Thu-- 01:30 GMT AU- Employment. Top economic indicator.


  • POTENTIAL PRICE RISK: Medium Thu-- 02:00 GMT CN- GDP. Top economic indicator.


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John M. Bland, MBA
co-founding Partner, Global-View.com

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