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The Return of Normal?

Market Directions


The Return of Normal?

By Joseph Trevisani, Published: 4/14/2009
Last Thursday the American equities had an excellent day. The three major averages rose more than 3.0% capping a five week rally that has been the sharpest since 1933. Wells Fargo, the large California bank, was the catalyst as it reported much better than expected first quarter earnings. But the entire financial sector participated, as speculation followed the Wells Fargo report and a press story that all major US banks will pass the Treasury Department’s ‘stress tests’ that the financial slump may be ending.

Nothing unusual here, good economic news produces an equities rally. And it is not really news that banks can earn a strong positive carry on their main businesses with Fed Funds at 0.25%. The unusual event is that the currencies played along. The dollar rose modestly, 1.3% against the euro and 0.8% versus the yen.

But not very long ago positive US economic news or a stock market rally might have produced a weaker dollar as traders kept their focus on the US currency’s risk aversion status. The fear and deleveraging mania of last fall gave the market the peculiar twist that only bad financial and economic news brought out the avid dollar buyers. When the news was good the dollar was either becalmed or shorted on the reversion of safe haven trades.

There has been a slow subsidence of fear from all the financial markets. Few analysts are expecting the extreme volatility of September and October to return. There is plenty of remaining economic worry but it has turned to the mundane questions of GDP growth, tax policy and the political attributes of the Obama administration’s stimulus package. The apocalyptical events of last fall are gone.

With the need for a haven currency ebbing traders are resurrecting the normal criteria for currency comparison, interest rate cycles and economic growth. Interest rates are currently a dead letter. With the possible exceptions of antipodean currencies, the Australian and New Zealand Dollars, no central bank can be credibly expected to begin raising rates before the middle of 2010. Even if central bankers were not fighting a worldwide recession, the specter of deflation, receding though it may be, is enough to wring six extra months of low rates from any conscientious banker.

But not only have markets begun to watch economic statistics again but selective interpretation has returned. When markets have a strong set of assumptions directing trading contrary or ambiguous information is often ignored or interpreted positively.

The United States International Trade Balance on Thursday was just such a number. At -$26.0 billions the deficit was the smallest in almost a decade, since November 1999. The rather astonishing 28% drop in one month was mostly due to an $8.2 drop in imports which are now at a five year low. Exports rose by $2.0 billions.

But lower imports are not a sign of economic growth especially with a strong dollar making the prices of overseas good cheaper. Weaker imports are an indication that consumers are still retrenching, paying down debt not buying and that consumption will remain a drag on economic growth. This negative interpretation was the initial reaction to the release as the euro climbed to nearly 1.3300.

The market also ignored first time unemployment claims which were above 600,000 for the tenth week in a row, and the record number of continuing claims at 5.84 million.

These statistics were the main items of economic news on Thursday each could have been negative for the dollar. But over the course of the day traders seemed to come to the conclusion that the powerful equity rally was more important. The euro closed at 1.3167 within 30 points of its low.

There are positive aspects of both statistics. In the longest analytical view it will be far better for the global economy if the United States has a sustainable trade relationship with the rest of the world. The US cannot maintain a trade deficit from a credit driven consumer economy forever. While it may temporarily benefit the exporting countries such a systemic deficit unbalances the world financial markets and was one of the contributing factors in the collapse last fall. Since unemployment statistics are considered a lagging indicator the longer you are along in a finite run the closer you are likely to be to the end; and after ten weeks there is little negative shock left in a mid 600,000 number.

But the more immediate interpretation of both numbers could also be negative for the dollar: shrinking imports signaling a contracting American consumer market and ten months of record job losses pointing to even more consumer fatigue in the future.

On the last real trading day before a holiday weekend, we saw the currency markets putting a positive spin on ambiguous statistics and then willfully pursuing the equities for uplifting economic news, these are two very potent psychological signs of a higher dollar to come.

 

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