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Forex Blog - Been Down So Long Looks Like Up From Here.

January 02, 2009


Been Down So Long Looks Like Up From Here.


In arguably flawed species characteristics, humans tend to see the start of each calendar year in terms of a new beginning...control alt delete on 2008. 


Yes it is simplistic but it is also part of the species survival…putting the past behind…especially dreadful past.


And so many are looking at 2009 as an improvement (variations on degrees of improvement) over 2008.  We are an optimistic lot to begin with and why not dip into the well of optimism as the New Year gets underway? 


So out of the gates, most (contrarians may use this to fade and I note that contrarians are not always right) are looking at 2009 from record low bond yields, a massive US dollar rally from July and the largest declines in global equity prices since the Great Depression, and concluding in a sort of primal way that asset prices have to improve in the next 12 months…its been down so long it looks like up to me. 


And there is some reasonable logic to being optimistic…Washington may get it more right on the policy front in 2009 than it did in 2007 and 2008 and actually keep the economy from falling into the black hole of deflation.  President-elect Obama, with an electoral mandate, is planning the largest fiscal stimulus in a generation aimed at kick starting the economy and more accurately filling the gap the private sector is leaving as households and firms pull back in the face of a serious recession.   With the TARP balance at $350bln and purported plans from Obama to add another $700-800bln in new spending and or tax cuts, there is serious firepower aimed at the economy.  And look for much of the early money bombardment to hit the housing market on the notion that this is where the financial crisis and then economic crisis started and where they must end.   


And the Fed will begin expanding its balance sheet by directly buying securities from the market rather than simply lending cash for collateral…this is the equivalent of printing money.   The Fed (and US Treasury) will work to support credit expansion outside the banking system (buying ABS in credit card, small business loans and student loans). 


Moreover, the policy response is global – every major economy is throwing fiscal and monetary accommodation at this problem – and will up the odds of the response working.   


And since much of the current malaise in asset prices and the real economy is rooted in confidence or lack thereof, there are real and some imagined reasons to view the incoming administration as well up the food chain of competence compared with what President Bush brought to Washington where cronyism and incompetence were rife and where government was considered the root of all evil – forced many of the long-term competent civil servants to leave government.  I think there is a degree of competence in Washington come January 20 that there is not now and has not been there for the better part of the last 8 years and this gives rise to the optimism the Obama administration getting it right (task is tall and risks great and only time will tell).


So I am of the belief that riskier assets and currencies should outperform at least through Q1 and possible Q2 – equities, corporate debt, munis, commodities and ABS (buy what c bankers are buying).  And risk free government bonds, from stupidly high levels, have some ground to give up (not predicting a reflation run on Treasuries and dollar).  I think 2009 is mainly an equity and bond opportunity and less a currency opportunity.  However, this (my view) also means the USD has more ground to give up versus commodity currencies, emerging market currencies and European currencies excluding the British pound. 


No doubt there are risks to the Obama optimism trade – Republican Congressional leadership is beginning to stir and questioning the scale of the stimulus Obama’s transition team has been batting around and could prove obstructionist (recall resistance to TARP and the auto bailout bill).  Even Congressional Democrats fear that the lack of detail in the Obama fiscal stimulus proposal makes any early passage (for January 20, 21 presidential signing) of fiscal stimulus less likely.  Furthermore, there is no reason to assume that foreign investors will feel comfortable committing more savings to the US public and private sector to pay for a qualitative change in US government debt issuance (good news is US public will save more ahead and will buy less foreign goods and services and compensate for some decline in foreign capital inflow). 


And then there are the longer term trades and trends – like the 2H 2009 when we will be able to assess the effectiveness of Obamanomics and Fed monetization.  Rising unemployment and falling home prices may be more than even massive monetary and fiscal policy accommodation can offset.  And I have little faith that the banking system will be up and running at anytime in 2009…more like major new writedowns in PE leveraged bank loans, home equity lines of credit, credit cards, business loans (unsecured credit lines or revolvers), student loans and hedge funds (banks sometimes own them and in most cases invest in them).  The problem for Fed and Treasury is there is not a great alternative to the major banks in creating credit and transmitting easier monetary policy – likes of credit card issuers, auto financing companies, regional banks not hobbled by subprime and ABS toxic waste and other non-bank consumer lending agents (like student loan firms) may not be sufficiently adequate as credit creation machine and transmission mechanism to compensate for the busted major banking system.  If I had to guess, the Obama honeymoon ends in late Q2 and sets the stage for new lows in equities in 2H 2009 and a rebound in risk free assets. 


One longer-term view I would bet against is that the Fed and government succeed this year in reflating the economy and monetary and fiscal policy accommodation give root to an inflation problem.  The next 12 months will be about firms and households surviving, not returning to old bad habits of indebtedness for current consumption/investment.  No amount of possible fiscal and monetary easing can fully account for the deleveraging ahead for banks (ongoing), households and many firms.


David Gilmore 


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