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Thursday October 29, 2009 - 22:16:27 GMT
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Forex Blog - USD Downtrend to Prevail

USD Downtrend to Prevail

If I had to score what caused USD to rally I would put it down to mainly one-way market, not real change in fundamentals.  But that said there have been some important changes in fundamentals including investors questioning current stock market valuations (bump up in risk aversion), worries about the strength of private sector activity in the US (household remains traumatized), worries about the health of large weak banks in the US and Europe, worries US Congress seeking to end too big to fail in favor of wind down authority for large weak banks, and reports in WSJ and FT that the Fed is considering dropping the language in its FOMC statement pledging to keep rates low for an extended period and replace it with some unspecified medium-term desire to raise rates assuming the recovery turns self-sustaining (private-sector led).  But nothing here is really going to change the trend in the USD until much later in 2010 IMHO. The rapidity of the rally from lows today in commodity currencies and even euro and GBP says it all.


Fed Ready to Signal Higher Rates?

Attention is already squarely fixed on next week's FOMC meeting Nov03-04 and whether the Fed changes its language on its commitment to keep rates low "for and extended period of time."  Hilsenrath of the WSJ and Guha of the FT have written very similar (informed) articles on the chance the FOMC may change language to introduce the notion that rates will have to rise as the economy recovers with the idea that rising commodity prices and falling dlr are in part a result of the open ended time commitment on rates.  But the Fed also risks igniting a major back up in rates (tighter credit) if it does so prematurely and this could backfire, delaying the recovery and putting more pressure on households and firms.  Frankly all Guha and Hilsenrath have shown is that there is an ongoing debate over the language regarding rates and perhaps driven to the surface by the weak dlr and rising commodity wonders if the correction in both this week makes the case for sticking to the current language more attractive.  I would bet so and do not expect to see any change on rate outlook language until a few meetings from now and when the economy is more out of the woods (or grasp of Washington). 


Government Domestic Product

Yes I know the difference between Gross Domestic Product and Government Domestic Product – the latter generated most of the former in today’s Q3 growth figures.  If anything the data warrant circumspection, not celebration.  White House Economist Summers said Q3 GDP showed admin policy success and economy is turning the corner.  This is correct as long as one recognizes that public policy is supporting GDP primarily and the only private sector lift came from housing investment and that is off an extremely low base and not a sign of a housing-led recovery in GDP.  What is less clear is what happens to GDP when government support fades.  No one knows for sure, but the cash for clunkers program showed that outside of a large gvt giveaway there is not much demand from consumers.  And one has to assume that the $8000 tax credit for housing is playing a similar role in home sales directly and new home construction indirectly.  But net exports, inventories and business investment all contracted.  Evidence of private sector sources of growth remain scant and don't see much change ahead with consumer confidence weak, unemployment rate high, household wealth down, declining real income and tight credit.


G20 Turns to China for Global Adjustment, Demand Policy Shift

Reading wire reports from unnamed ECB sources today warning that EURUSD above 1.50 would be unwelcomed and could throttle the recovery makes me a little wary of the intended message.  Surely no official in the Euro Zone wants EURUSD above 1.50 for the near-, medium- or long-term.  But officials in Europe know there is nothing they can do about the weak USD now so long as the Fed keeps the funds rate near zero and US officials hope the orderly decline to date in the dollar will result in more net exports.  And ECB’s Noyer said Wednesday the problem in FX is the undervalued Chinese yuan, not the EURUSD exchange rate.  Indeed the greater revelation by Noyer if implied is that the US consumer has experienced a paradigm shift from spenders to savers and EZ exports of the future may have much greater chance of expansion in China than the US.  While the US current account imbalance remains large and the yuan fixed artificially low against the USD, the major economies’ floating currencies bear most of the adjustment burden.  With ECB and Eurogroup  epresentatives heading to China ahead of G20 in Scotland in November, China is the real medium- to long-term problem.  The dollar will take care of itself so long as Washington in due course comes up with a credible plan for reducing the deficit (starting point is a growing economy led by the private sector).   I think anyone who is looking at a paradigm shift in US consumption should know that you can't get blood from a stone with higher USD vs EUR ahead on trade if US is now a nation of savers.


David Gilmore


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