A Pfennig For Your Thoughts

In This Issue…

  • Geithner sends the dollar on a thrill ride…
  • A failed UK gilt auction…
  • China set to recover first…
  • AUD and NZD rally again…

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And Now… Today’s Pfennig!

Geithner Tanks the Dollar, But Then Pushes It Back Up…

Good day… The currency markets took back what little strength the dollar mustered over the past two days with the euro moving back above popping back above 1.36 and the Australian dollar moving back up over .70. The cause for this dollar weakness? Data released in the U.S. yesterday was surprisingly strong again, so investors dumped the “safe haven” holdings of Treasuries and moved money back into higher-yielding investments.

At one point yesterday the dollar index dropped precipitously (more than 1.5% in less than 10 minutes), and then bounced back up within a half hour. Jennifer McLean, who takes care of our currency trading while Chuck is away from the desk, said the sudden moves were due to Treasury Secretary Geithner’s comments. Apparently Geithner was asked about China’s call for a new international reserve currency yesterday at an NY event. He said that while he hadn’t read the proposal, he understood it as a plan “designed to increase the use of the IMF’s special drawing rights. And we’re actually quite open to that.” After hearing those words, currency traders immediately starting selling off the dollar. After all, if the Treasury Secretary of the U.S. says the administration is open to a new international reserve currency, why do you want to hold dollars? I guess Geithner got wind of what he had done to the currency markets pretty quickly (the power of Blackberries!), and 15 minutes later he clarified his comments to say the U.S. dollar should remain as the world’s reserve currency.

So the Treasury Secretary got a quick lesson in just how sensitive the currency markets are. The props which have held up the U.S. dollar can be kicked out from under it with a few words from him. I have got to believe the quick sell-off yesterday is a sign of what will happen in the coming months as we hear more and more rhetoric about the need for an alternative reserve currency. Foreign nations are not going to want to continue to invest a majority of their reserves in a currency which is likely going to be losing value because of the inflationary impact of all of the debts and deficits here in the U.S. If the Eurozone can show some signs of stability, it could take advantage of the weakened state of the US$ to challenge for the reserve currency status. Just what Chuck has been talking about over the past few years.

The big story out of Europe yesterday was the failure of the UK bond auction. The UK Government held an auction to sell 1.75 billion pounds of bonds (commonly called gilts) yesterday. For the first time in 7 years, not enough buyers showed up at the auction, so the UK couldn’t sell all of the gilts. This auction “failure” sent interest rates up in the UK as investors demanded higher yields. The main reason the UK couldn’t attract enough buyers were their quantitative easing efforts of late. You see, the Bank of England was one of the first to announce they would be buying UK gilts in an effort to bring down interest rates and stimulate the economy. Sound familiar? This is what the Obama administration is going to do with last week’s announcement that it would be purchasing $300 billion of U.S. Treasuries.

This effort to drive rates lower than what the market dictates causes investors to just stay away from the auction. So it creates an environment where the government is the only willing buyer of their own debt, a situation that can become hyperinflationary. So the government must eventually attract outside investors back into the debt auctions. To do this, they either have to let interest rates rise or let their currency value fall, making the purchases more attractive to outside investors. A combination of the two is the most likely scenario. This is the path the UK has started to walk down with the U.S. close on their heels.

Chuck alerted me to the failed gilt auction yesterday and sent me this note: “Oh… And did you hear that in the U.K. their gilt auction (their Treasuries) failed yesterday? Now, hasn’t just about everything that happened here in the U.S. during this financial meltdown happened first in the U.K.? Well… I think this is an ominous omen that they couldn’t get enough buyers for their debt auction…”

As I reported in the first paragraph, the U.S. data releases continued to be surprisingly strong. Both durable goods and sales of new homes unexpectedly rose in February, according to yesterday’s reports. Durable goods orders jumped 3.4% in February, after dropping a revised 7.3% in January. This increase was the largest in more than a year and the first positive move in seven months. The other big piece of data released by the Commerce Department showed New home sales increased 4.7% vs. the January sales. These two positive numbers eased fears in the equity markets and encouraged investors to take more risks. This is why positive economic data releases in the U.S. cause a sell-off in the US$ (the reversal of the trend we were seeing earlier this year).

Does anyone find it odd that all of the data we are seeing this week are surprisingly strong, while the revisions to the prior month’s data show even bigger drops? I’m not accusing the government of massaging the numbers (wink wink) but it just seems odd. Today we will see the GDP numbers from 4th quarter of 2008. The economists are predicting a drop of 6.6% during the last quarter, but the trend with data releases this week would suggest the number will come a bit stronger. We will also see the weekly jobless claims, which are expected to show another 650k U.S. citizens were out of a job last week.

This would be the eighth consecutive week of a 600k+ number for jobless claims. The jobs numbers will have to start improving if the U.S. is going to really turn things around.

The strength of the euro was somewhat tempered by the release of German business confidence data, which fell to the lowest level in more than 26 years. The global economic slump is weighing heavily on German companies that rely on exports. The data gave support to those calling for another rate cut by the ECB. The euro has been caught in a fairly narrow trading band this week, as it has benefited from calls for an alternative reserve currency, but sold vs. poor European economic data.

China’s central bank Governor Zhou Xiaochuan helped investor confidence with a statement that the Chinese economy is recovering. “Leading indicators are pointing to recovery of economic growth,” Zhou said in an article on the central bank’s website today. The government “has taken prompt, decisive and effective policy measures, demonstrating its superior system advantage when it comes to making vital policy decisions,” he said. China continues to try and keep their economy growing above 8%, and will continue to be the growth engine of the global economy. A strong Chinese economy is good for the commodity markets, and global recovery.

As predicted, New Zealand’s current account deficit widened to a record last year as exports fell. Finance Minister Bill English said this week the deficit is “uncomfortably large” and makes New Zealand dependent on foreign funding. It is actually nice to hear a finance minister worried about the long-term impact of running large current account deficits! Here in the U.S., all we hear is “deficits don’t matter.” But the growing current account deficit is the main reason Chuck suggested investors move out of the kiwi last year, and we still think the Australian dollar is a better currency to own.

Both currencies rallied again yesterday, as investors moved out of “safe haven” U.S. Treasuries and into these higher-yielding currencies. The Australian dollar also benefited from an statement by the Rio Tinto Group that predicted the metals markets would recover in the second half of 2009. Commodities account for over 60 percent of Australia’s exports, and 70% of exports in New Zealand. If data continue to show China is on solid footing, these two currencies should continue to appreciate.

It is getting late, so I will head right to the currency wrap-up:

Currencies today 3/26/2009: A$ .7020, kiwi .5770, C$ .8142, euro 1.3574, sterling 1.4561, Swiss .8883, rand 9.4226, krone 6.4553, SEK 8.0229, forint 222.57, zloty 3.3561, koruna 20.1542, yen 98.35, sing 1.5080, HKD 7.75, INR 50.5625, China 6.8319, pesos 14.172, BRL 2.2378, dollar index 83.77, oil $53.53, silver $13.575, and gold… 935.77

That’s it for today… Going to be a late night for me this evening, as I get to attend the Blues game here in St. Louis and then stay up to watch the Mizzou/Memphis game on the television. The Blues are just one point out of a playoff spot, so every game is a must-win. Hopefully tomorrow I will be telling all of you about two terrific wins! I hope everyone has a Tub Thumping Thursday! (I heard on the radio last night that Tub Thumpers are what they call politicians in England, and that Tub Thumping is campaigning or getting up on your soap box. We have been doing a lot of that lately in the Pfennig!)

Chris Gaffney, CFA
Vice President
EverBank World Markets