Foreign Economies Could Distance Themselves From The Dollar

It is no secret that many countries would like to decrease their dependency on the dollar. For instance, BusinessWeek says China owns $2 trillion in dollar assets and could be a big loser if the dollar was weakened. According to foreign exchange currency expert Kathy Lien, several nations may take action to distance themselves from the dollar in the coming months.

The U.S. dollar has weakened significantly driving many of the major currencies to the highest level in months. Here’s a table illustrating the significance of today’s moves. I expect at least another 2 percent decline in the U.S. dollar against the key currencies (Short and Long Term Outlook for U.S. Dollar).

The fact that USD/JPY is not participating in today’s rally indicates that investors’ distaste for dollars rather than their risk appetite is driving the dollar lower. The modest gains in Dow futures and the sharp rise in gold prices confirm that investors are bailing out of dollars. In my interview with Fox Business 2 days ago, I talked about how the one takeaway from the concern about the credit worthiness of the U.S. is the need for diversification.











Yesterday, a Brazilian official said that the BRIC nations (Brazil, Russia, India and China) could take unilateral action to reduce their dependency of dollars at their summit next month. Brazil has already begun to replace the dollar bilaterally in their trade with China and unfortunately this trend could continue with other nations following suit in the coming weeks and months. The one thing that the financial crisis has taught investors large and small is need for diversification and no one wants to sit with baskets full of dollars waiting for S&P to make an announcement. Sovereign Wealth Funds are taking this to heart which could create a fresh supply of dollars.

This post can also be viewed on kathylien.com.

Could The Yuan Become The World's Next Reserve Currency?

The U.S. dollar has faced some serious attacks lately, and our economy here in the U.S. is struggling, but have things really gotten so bad that the USD could lose its place as the world's reserve currency? And even if it did, wouldn't the Euro be next in line to take its place? According to Nouriel Roubini, the next world reserve currency could in fact be the Chinese Yuan, and the transition could happen sooner than we think. For more on this, read the following blog post from Mark Thoma which looks at Roubini's recent article on the subject.

Nouriel Roubini is worried that the dollar will lose its status as a reserve currency if we don't change our ways:

The Almighty Renminbi?, by Nouriel Roubini, Commentary, NY Times: ...While the dollar’s status as the major reserve currency will not vanish overnight, we can no longer take it for granted. Sooner than we think, the dollar may be challenged by other currencies, most likely the Chinese renminbi. This would have serious costs for America, as our ability to finance our budget and trade deficits cheaply would disappear. ...

The... downfall of the dollar may be only a matter of time. But what could replace it? The British pound, the Japanese yen and the Swiss franc remain minor reserve currencies, as those countries are not major powers. Gold is still a barbaric relic whose value rises only when inflation is high. The euro is hobbled by concerns about the long-term viability of the European Monetary Union. That leaves the renminbi. ...

At the moment,... the renminbi is far from ready to achieve reserve currency status. China would first have to ease restrictions on money entering and leaving the country, make its currency fully convertible for such transactions, continue its domestic financial reforms and make its bond markets more liquid. It would take a long time for the renminbi to become a reserve currency, but it could happen. ...

We have reaped significant financial benefits from having the dollar as the reserve currency. In particular, the strong market for the dollar allows Americans to borrow at better rates. We have thus been able to finance larger deficits for longer and at lower interest rates, as foreign demand has kept Treasury yields low. We have been able to issue debt in our own currency rather than a foreign one, thus shifting the losses of a fall in the value of the dollar to our creditors. Having commodities priced in dollars has also meant that a fall in the dollar’s value doesn’t lead to a rise in the price of imports. ...

This decline of the dollar might take more than a decade, but it could happen even sooner if we do not get our financial house in order. ... For the last two decades America has been spending more than its income, increasing its foreign liabilities and amassing debts that have become unsustainable. A system where the dollar was the major global currency allowed us to prolong reckless borrowing.

Now that the dollar’s position is no longer so secure, we need to shift our priorities. This will entail investing in our crumbling infrastructure, alternative and renewable resources and productive human capital — rather than in unnecessary housing and toxic financial innovation. This will be the only way to slow down the decline of the dollar, and sustain our influence in global affairs.

This post can also be viewed on economistsview.typepad.com.

What Is The Likelihood Of The U.S. Losing Its AAA Credit Rating?

A few months back — after Moody's issued a warning — there was a lot of talk about the possibility of America losing it's AAA credit rating. Of course that never materialized. Now after a recent report on the health of Social Security and Medicare, the talk is resuming. The question still remains though of whether all this talk, is just talk, or if there is any merit to it. Kathy Lien looks closer at the question in her blog post below.

In today’s Financial Times, there is an op-ed article by David Walker, the CEO of the Peter G. Peterson Foundation pondering the possibility of the U.S. losing its prized AAA credit rating. The paper focuses on a warning that was issued by rating agency Moody’s months ago. Moody’s has not issued a new warning, yet Walker and in turn, the FT has decided to re-inject uncertainty into the financial markets by resurrecting this fear. What has prompted this article is most likely the recent comments about the insolvency of the Social Security and Medicare systems. According to the trustees for the systems, the Social Security trust fund could be depleted by 2037 while Medicare could be insolvent by 2017. These dates of insolvency have been pushed up as the weak labor market reduces contributions. The Obama Administration has pressed the importance of gaining control of the growth in Medicare costs and their desire to tackle Social Security insolvency once health care reform is passed.

According to Walker, if the health care reforms strains finances further or if the federal government fails to monitor spending, tax or budget control, rating agencies could strip the U.S. of its credit rating.

Is Losing AAA Rating that Big of a Deal?

But is losing the AAA rating that big of a deal? Yes. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt. Some global funds are mandated to invest only in AAA debt and therefore if the U.S. loses its AAA rating, we could see a massive outflow of foreign investment. Also, a credit rating downgrade is the perfect excuse to push through an alternative reserve currency to replace the dollar because it would strip the confidence of sovereign funds like China that have been buying dollars to prop up the U.S. economy. Yes, investors will still buy U.S. Treasuries, but their purchases will be less. It could also have a spillover effect on corporate debt and will raise the cost of borrowing for the U.S. government.

How Real is the Risk?

Now with the risk in mind, I think that ratings agencies talk a good game but they will face problems following through. The consequences of downgrading U.S. sovereign debt is huge both politically and economically. Therefore Moody’s or any rating agency for that matter may be reluctant to the first to pull the trigger. Downgrading the U.S. is very different from downgrading Ireland. Based upon how the rating agencies have handled the credit derivatives bubble, chances are they will be behind the curve once again.

With that in mind, U.S. finances are deteriorating significantly, raising the concern of Asian nations. However if President Obama is successful at turning around the U.S. economy, America will be well equipped to meet its debt obligations.

This post can also be viewed on kathylien.com.

Japanese Yen Could Be In For A Significant Slide

The Japanese Yen has performed well the past few days, but the USD/JPY could be approaching a wall. Currency expert Kathy Lien warns that the USD/JPY is trading at a critical level and could be in for a significant slide. For more on this, read her blog post below.

The U.S. dollar has sold off significantly against the Japanese Yen over the past 2 trading days. It is nearing a very important support level. If it breaks that level, we could see a test and potential break of 95. Given that equities are pressuring USD/JPY lower, a “break” of the 95 level would be contingent upon a top in equities. In my special report on FX360, I talk about the fundamental reasons behind the sell-off in USD/JPY.

On a technical basis, the chart below illustrates how USD/JPY is approaching very critical levels. We have a major head and shoulders pattern in place, the currency pair is attempting to enter the sell zone according to our Bollinger Bands and is approaching trend line support. For those of you that like Ichimoku clouds, it has also entered the cloud. Therefore a close below 96.80 would open the door for a significant slide.

Click on Chart to see Larger Version

This post can also be viewed on kathylien.com.

How The European Central Bank Is Different

The European Central Bank (ECB) made several important announcements today, and the reaction from currency traders was much different than how they have reacted to similar moves from other central banks. Currency expert Kathy Lien looks closer at the recent announcements, and talks a bit about what sets the ECB apart from the Bank of England and Federal Reserve, in her blog post below.

Both the European Central Bank and the Bank of England announced asset purchases today, but the Euro skyrocketed while the British pound fell, leading many currency traders to wonder What Sets the ECB Apart from Fed and BoE?

Read Boris’ take on the Bank of England Rate Decision

Before talking about why the euro recovered, here are the 4 key announcements made by the ECB today:

1. Cut Repo Rate from 1.25 to 1.00%
2. Narrow Rate Corridor by 50bp (Marginal Lending Rate Cut by 50bp to 1.75%)
3. Extend maturity of refinancings to 12 months
4. Announced purchases of up to EU60 billion in euro-denominated covered bonds

There is no question that these are unprecedented measures for the European Central Bank. Everyone expected the quarter point rate cut to a record low of 1.00 percent, the decision to increase the maturity of refinancings to 12 months and also the narrowing of the rate corridor by 50bp, but the chance of purchasing euro-denominated covered bonds was low.

Nonetheless, Trichet has resorted to what many consider Quantitative Easing (even though he explicitly denied that this is QE) and rather than punishing the euro, currency traders are applauding the ECB for being flexible and realizing that there is no longer a stigma attached to asset purchases. Also, the amount of bonds that the ECB is purchasing is nominal compared to the rest of the central banks. The ECB plans on buying up to EU60 billion, which is less than half of the BoE’s Quantitative Easing program. More importantly however, Trichet suggested that they may sterilize the liquidity impact of bond purchases, which would limit the impact on the money supply and the pressure on the euro. The Fed and the BoE’s purchases are unsterilized. Finally, this is only an initial announcement. Further details on the bond plan will be released in June. Although rates are appropriate for the current time, the central bank could still take interest rates below 1 percent based upon Trichet’s comment that they have decided if rates have hit their lowest point.

This post can also be viewed on kathylien.com.

Expectations Of A Dollar Collapse

So far — despite the huge run up in U.S. debt — the U.S. dollar has held strong during the financial crisis, however, Andy Xie expects a major collapse to come. He feels that pressures from China, and an overall loss of faith in the U.S. financial policy, will destroy the greenback. For more on this, read the following blog post from Mark Thoma.

Andy Xie expects the dollar to collapse:

If China loses faith the dollar will collapse, by Andy Xie, Commentary, Financial Times: Emerging economies such as China and Russia are calling for alternatives to the dollar as a reserve currency. The trigger is the Federal Reserve’s liberal policy of expanding the money supply to prop up America’s banking system and its over-indebted households. ...[T]he Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyper-inflation and cause great damage to countries that hold dollar assets in their foreign exchange reserves.

The chatter over alternatives to the dollar mainly reflects the unhappiness with US monetary policy among the emerging economies that have amassed nearly $10,000bn in foreign exchange reserves, mostly in dollar assets. ...[T]he US situation is unique: it borrows in its own currency, and the dollar is the world’s dominant reserve currency. The US can disregard its creditors’ concerns for the time being without worrying about a dollar collapse. ...

The faith of the Chinese in America’s power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar’s global status. Ethnic Chinese ... may account for half of the foreign holdings of dollar assets. ...

The US could repair its balance sheet through asset sales and fiscal transfers instead of just printing money. ... The country’s vast and unexplored natural resource holdings could be auctioned off. Americans may view these ideas as unthinkable. It is hard to imagine that a superpower needs to sell the family silver to stay solvent. Hence, printing money seems a less painful way out. ...

Other currencies are not safe havens either. ... Central banks are punishing savers to redeem the sins of debtors and speculators. Unfortunately, ethnic Chinese are the biggest savers.

Diluting Chinese savings to bail out America’s failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar’s global status. Ethnic Chinese demand for the dollar has been waning already. ...

America’s policy is pushing China towards developing an alternative financial system. ... Its recent decision to turn Shanghai into a financial centre by 2020 reflects China’s anxiety over relying on the dollar system. The year 2020 seems remote... However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse.

Barry Eichengreen explains why using SDRs as a reserve currency, as has been suggested by the governor of the People's Bank of China, is not as easy as it might seem:

Commercialize the SDR now, by Barry Eichengreen, Commentary, Project Syndicate: Zhou Xiaochuan, the governor of the People’s Bank of China, made a splash prior to the recent G-20 summit by arguing that the International Monetary Fund’s Special Drawing Rights should replace the dollar as the world’s reserve currency. ...

Sympathizers acknowledged the contradictions... Central banks understandably seek more reserves as their economies grow. But if those reserves mainly take the form of dollars, then their rising demand allows the United States to finance its external deficit at an artificially low cost. In turn, this allows unsustainable imbalances to build up, leading to an inevitable crash. ...

But skeptics question whether the SDR could ever replace the dollar as the world’s leading reserve currency, for the simple reason that the SDR is not a currency. It is a composite accounting unit in which the IMF issues credits to its members. Those credits ... cannot be used in the other transactions in which central banks and governments engage. ... This means that the SDR is not an attractive unit for official reserves.

This would not be easy to change. Despite the trials and tribulations of the American economy, dollar securities remain the dominant form of reserves because of the unparalleled depth and liquidity of US markets. Central banks can buy and sell dollar securities without moving those markets. There is also the convenience factor: dollars are widely used in a variety of other transactions. As a result, not even the euro has seriously challenged the dollar as the dominant reserve currency. ...

If China is serious about elevating the SDR to reserve-currency status, it should take steps to create a liquid market in SDR claims. It could issue its own SDR-denominated bonds. ... Of course, an earlier attempt was made to create a commercial market in SDR-denominated claims ... in the 1970’s... But these efforts ultimately went nowhere. The dollar being more liquid, its first-mover advantage proved impossible to surmount.

Overcoming that advantage now would require someone to act as market-maker ... and subsidise the market in its start-up phase. The obvious someone is the IMF. The Fund could stand ready to buy and sell SDR claims to all comers, ... at narrow bid/ask spreads competitive with those for dollars. ...

Transforming the SDR into a true international currency would require surmounting other obstacles. The IMF would have to be able to issue additional SDRs in periods of shortage... The IMF’s management would also have to be empowered to decide on SDR issuance, just as the Fed can decide to offer currency swaps. For the SDR to become a true international currency, in other words, the IMF would have to become more like a global central bank and international lender of last resort.

For worries about inflation, see Inflation Nation by Alan Meltzer (and also see Krugman's response, A History Lesson for Alan Meltzer).

[Note: A lot of people have noted the apparent contradiction in the concern from Krugman over deflation, and from Meltzer over inflation, e.g. Mankiw for one, but here's an example of this from Mankiw's colleague, Martin Feldstein, within the same article. It's simply a short-run, long-run distinction.]

This post can also be found on economistsview.typepad.com.

Treasury Yield: What Does The Future Have In Store?

A lot of people have been turning to Treasuries as the investment of choice in these unpredictable and rough economic times, but will it ultimately prove to be a good move? While widely considered "risk free" investments, that is far from the truth. There are many things that perspective Treasury investors need to keep in mind when weighing their investment options. The following blog post from James Picerno offers some insight into what is going on right now in the Treasury market, and hopefully will help investors make an a better informed decision.

It's hard to dismiss the ongoing news about China's anxiety over its massive holdings of American debt. What's worrisome for China is ultimately a concern for the U.S., with fallout that may come sooner than we think.

“We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried," Chinese prime minister, Wen Jiabao, said last month. It was a rare public admission of apprehension by a high-ranking Chinese official on the delicate and increasingly precarious lender-borrower relationship that describes the U.S. and China.

Yesterday came word that China's purchases of U.S. bonds slowed in the first two months of this year, according to new data from China's central bank, The New York Times reports. "Chinese reserves fell a record $32.6 billion in January and $1.4 billion more in February before rising $41.7 billion in March, according to figures released by the People’s Bank over the weekend," the Times notes. The trend may now be reversing, although the notion that a pivotal point in the U.S.-China financial relationship may be near remains intact.

The fear is that China will slow (cease?) buying new Treasuries, a decision that's likely to force up interest rates in the U.S. For the moment, there's no reason to dismiss that scenario, at least when it comes to the recent trend in the yield on the benchmark 10-year Treasury Note. As the chart below shows, the march upward to the 3% mark is alive and well.

What makes the rising yield in the 10-year so striking is that it comes in the wake of the Federal Reserve's announcement last month that it would directly target lowering rates on long Treasuries. The market's initial reaction was to buy Treasuries, which resulted in one of the biggest one-day drops in interest rates on record. For a time it looked like Bernanke and company had struck gold. But confidence that the central bank has complete control over the long end of the curve has been evaporating in recent weeks.

As the above chart shows, the 10-year yield collapsed by around 50 basis points on March 18, down to around 2.5%. As of April 9, the 10-year's yield had climbed by to roughly 2.9%, just under the level where when the Fed made its bombshell announcement last month.

High interest rates in the U.S. necessarily make the dollar more attractive, at least for a time. No wonder, then, that the buck's value is rising in forex markets in recent weeks, in sympathy with higher interest rates on the 10-year. The U.S. Dollar Index is just about at the highest level since the Fed's March 18 disclosure, a news event that had initially sent the buck tumbling. Meanwhile, commodity prices generally have been inching higher as well, as per the CRB Index. Commodities are generally priced in dollars, so it's no surprise that a strong dollar equates with higher commodity prices.

Higher interest rates are almost surely the path of least resistance in the years ahead, in part because the U.S. deficits are sure to be large in the wake of all the monetary and fiscal stimulus of late. The problem is that the arrival higher interest rates now, this week, next month, next quarter come at an especially inopportune time: before the economy has sufficiently recovered. The Fed surely seeks to keep long rates below 3% for the rest of the year, or so one might speculate. But it's not clear that the markets are willing to go along for the ride.

In the old days, the Fed's powers were such that it had more control over keeping interest rates low and thereby providing the economy with ample monetary stimulus until the forces of growth rose anew. Engineering that scenario this time may be tougher, much tougher. One reason is that much of the control over future rates has been transferred to foreigners, courtesy of holding large quantities of U.S. debt. That may not be fate that rates will rise. Indeed, China surely wants to keep U.S. rates low in order to boost growth here, which will promote imports of Chinese goods. But no one really knows how these forces will play out.

Perhaps the cycle will be salvaged if the economy rebounds quicker than the crowd expects. Alternatively, the Chinese and other foreigners decide to buy large quantities of Treasuries in the months and quarters ahead. There are solutions to the current dilemma, but no one should expect that they're a forgone conclusion.

This post can also be viewed on capitalspectator.com.

Geithner's Comments Are Moving The Currency Markets

Timothy Geithner should quickly learn that currency traders take everything he says literally. Recent comments he made caused the dollar to take a nose dive. Geithner quickly followed those comments up with a retraction of sort, which left the markets unsure of his true intent. Currency expert Kathy Lien address this matter further in her blog post below.

How long will it take for Treasury Secretary Tim Geithner to realize that his comments move markets? When he first took office, he mistakenly threatened to brand China as a currency manipulator. This caused a wave of volatility in the currency market and sharp criticism about the experience of the new Administration. And now, Geithner has done it once again (Geithner Comments send Dollar for a Ride).

Even though President Obama said that the dollar is strong and there is no need for a reserve currency, Geithner suggested this morning that the U.S. is “quite open” to China’s suggestion of moving towards a Special Drawing Right (SDR) linked currency system. But just as quickly as he made those comments, he retracted them probably because an aide told him that the U.S. dollar is tanking. Minutes later, Geithner said there is “no change in dollar as world’s reserve currency and likely to remain so for long time.”

These contradictory statements are clearly the act of an amateur Treasury Secretary that is forced to eat his words.

Why has the dollar had such a big reaction to these comments? Because if the world adopts the SDR, which was created by the IMF as an international reserve asset, it would mean less demand for U.S. dollars.

source: eSignal

This post can also be viewed on kathylien.com.

China Beginning To Use Monetary Leverage On U.S.

While the U.S. has racked up trillions in debt, China has been buying up this U.S. debt. Now China owns more U.S. debt than any other country on the planet, and of course with that comes a great deal of political power over the U.S. China owns so much of our debt that if they were to start selling it off in mass quantity it could collapse our entire financial system. China has not said that they have any intention of doing so, nor would it be financially wise for them to, however, the threat alone carries a lot of weight. One of Obama's campaign claims was that he intended to fight China's monetary manipulation, but with little surprise — after urging from China — the U.S. backed down. Now China is urging the U.S. to be more prudent with their stimulus spending — in order to protect the value of their investment. Kathy Lien dives more into this story in her blog post below.

According to the latest data from Treasury, foreign investors were net sellers of U.S. dollars. The Madoff scandal led to a tremendous amount of liquidation by hedge funds in the Caribbean and Luxembourg but we have our eye on China. The Asian Giant continues to be a net buyer of dollar denominated investments, albeit at an increasingly sluggish pace. For the third month in a row, China has slowed their purchase of U.S. dollars. There are many reasons why their demand for dollars is waning, but don’t expect them to become net sellers of U.S. dollars anytime soon ahead of the Treasury’s report on Currency Manipulation next month.

With a month to go before the report is due for release, China is flexing their muscles. This weekend, Chinese Premier Wen Jiabao signaled to the U.S. that they are fully aware of the power they have on the U.S. economy and how the U.S. needs China just as much as China needs the U.S. He said that “we lent such huge funds to the United States, and of course we’re concerned about the security of our assets.” If China decided that U.S. investments are no longer safe, their liquidation would drive yields significantly higher and stocks significantly lower. The consequences of infuriating China are severe because they have the power to retaliate.

China’s continual accumulation of U.S. Treasuries is also political. With a growing U.S. deficit, there are much better ways for China to spend their money such as investing in resource companies. The sharp decline in Chinese exports also automatically reduce their need to weaken the Yuan by buying U.S. dollars. However for political reasons, the Feb and March TIC data should continue to report that China is a net buyer of U.S. dollars.

CNBC VIDEO: Is US Debt Still Desirable to China?

This post can also be viewed on KathyLien.com.

The Most Indebted Countries By Percentage Of GDP

When you take a look at the list of the most indebted countries, you would assume that the U.S. would be tops on the list. That would certainly be the case if you just looked at the total amount owed, however, a better measurement of a country's debt load is to compare it to their GDP. When you do that the U.S. still looks bad, but we are no where near as bad as Japan — who runs away with the top spot. Kathy Lien looks at these numbers, and discusses some possible implications, in her blog post below.

The Economist has a great image on which countries have the most debt as a percentage of GDP. Japan tops the list followed by Italy and the United States. Japan actually has 2x more debt than the U.S. which I find particularly scary and leads me to wonder if Japan could face a ratings downgrade.

Source: Economist

This post can also be viewed on kathylien.com.

Switzerland Cuts Interest Rates: Swiss Franc To Fall Hard

Switzerland has decided to match the U.S. Central Bank's near zero interest rate policy and as a result the Swiss Franc is set to take a beating. Currency expert Kathy Lien explains the impact of Switzerland's decision on their currency, and even throws out some potentially profitable trades for currency investors in her blog post below:

Switzerland has officially adopted a beggar thy neighbor policy approach by intervening in the currency market. This morning, they cut interest rates by 25bp to 0.25 percent matching U.S. levels. They have officially embarked on Quantitative easing and will be buying domestic and foreign bonds (fully synopsis of SNB rate decision) .

Source: FX360.com

For currency traders, this means that a BIG seller of Swiss Francs have just entered the market. They have deep pockets and will probably be in the market for a while. Therefore, expect more losses in EUR/CHF and USD/CHF, both of which have hit 2 month highs. Such a strong move begs a correction but ultimately, I believe that EUR/CHF will hit 1.55 and USD/CHF will break 1.20.

The US retail sales report was much stronger than the market expected and this should add to the gains in USD/CHF, which has already outperformed EUR/CHF this morning.

There are still unanswered questions such as how much Swiss Franc the SNB will sell, the scale of bond purchases and additional liquidity. Their announcement today is aimed at accomplishing 2 goals at their expense of their neighbors which is protect their export sector and prevent the economy from falling into a deflation trap.

This post can also be viewed on kathylien.com.

The Pound And Euro Are Taking A Beating

The recent interest rate cuts by the Bank of England and the European Central Bank have lead to major selling of the Pound and Euro. Currency expert Kathy Lien talks about the recent development and offers her insight into the situation in her blog post below.

The Euro and British pound have come under severe selling pressure after the ECB and BoE cut interest rates by 50bp. Interest rates are now at historic lows for both central banks and even though the rate announcements were negative for both currencies, the Euro has sold off more aggressively than the British pound because ECB President Trichet warned that growth will be signicantly reduced in 2009 and 2010 while inflation will remain well below 2 percent.

More importantly, he admitted that the ECB is studying non-standard measures which include quantitative easing. However, Trichet prefers to use the Fed’s label of credit easing over quantitative easing (What is the Difference Between Credit and Quantitative Easing?). The mere possibility that the ECB could consider Quantitative Easing was enough to drive the EUR/USD below 1.25. With the third highest interest rate of the G10 nations, further interest rate cuts are still possible. By saying that they have not made a decision about whether 1.5 percent is the lowest level makes 1 percent interest rates a real possibility for the Eurozone. In fact, Trichet may opt for another rate cut before credit easing. For the US dollar, British pound and Japanese Yen, no surprises are expected from future rate decisions. However for the Euro, the prospect of lower interest rates and the uncertainty of if and when the ECB will adopt credit easing should keep the EUR/USD under pressure.

Bank of England: Rates May Have Hit Rock Bottom

As for the Bank of England, I believe today’s 50bp rate cut to 0.5 percent is their last. The central bank has been worried that excessively low interest rates would erode profitability of banks, reducing their incentive to lend. Now that they have been given the authorization to begin Quantitative Easing, it will be their new focus. UK Gilts have soared on the announcement that the government will purchase up to £100bn in Gilts and £50bn in private sector assets (syndicated loans and ABS). As we indicated in our ECB and BoE preview, Quantitative Easing is negative for a currency, but if the BoE is done cutting interest rates, further weakness in the British pound may be limited.

This post can also be viewed on kathylien.com.

Currency Market Update: Look To The Australian Dollar

Yesterday's market rally got a lot of investors excited, but the rally was short lived. Currency expert Kathy Lien points out 3 reasons why investors should have been suspicious of the rally in her blog post below. In addition Lien offers some insight into the future of currencies, and suggests that the Australian Dollar might be a great investment opportunity right now.

The currency and equity markets are turning lower after a strong rally on Tuesday. In my Daily Currency Focus, I talked about the 3 reasons why the currency market rally was suspicious. None of the reasons for Tuesday’s jump delivered real solutions. The market only rallied because Bernanke delivered no surprises. President Obama’s attempt at reassuring Americans also failed to comfort investors.

Instead we are faced with a weakening economy that is only confirmed by this morning’s plunge in existing home sales. Sales of existing homes plunged 5.3 percent to a 12 year low in the month of January. The housing market remains the Achilles heel of the US economy as prices fall and demand wanes. The median price of a home sold dropped 14.8 percent compared to the year prior. Such disappointing numbers are not much of a surprise given the big decline in housing starts and building permits. With banks and mortgage lenders reluctant to lend, even potential homeowners with sufficient capital have found difficulty attaining loans.

The British pound has been hit the most because Bank of England member Barker said that the weak sterling is helpful. UK officials have taken every opportunity to talk down the currency.

USD/JPY on the other hand remains an animal. Despite weak economic data and a turn in equities, the currency pair continues to rise.

My favorite is still the Australian dollar because of strong M&A flow, higher gold prices and the prospect of the country remaining recession free. The AUD/USD is also prime for a breakout.

This post can also be viewed on kathylien.com.

Geithner's Financial Stability Plan

This morning the new plan to rescue the financial system was unveiled by Treasury Secretary Timothy Geithner, but so far the markets have not reacted very positively to the news. It is still early, but it appears investors are not sold on the proposed government actions. In his speech Geithner threw around numbers as high as $1 tillion, which represents the expansion of a key Federal Reserve lending program, according to the Associated Press. But even that failed to impress investors. Kathy Lien talks more about the new rescue plan and the impact to currency and financial markets in her blog post below.

The Treasury Secretary has finally spoken and the markets are disappointed!

The price action in the currency markets suggests that investors are disappointed by the lack of details from the Treasury’s new Financial Stability Plan and are skeptical about the effectiveness of getting the private sector involved. Furthermore, investors are not happy about being apart of an experiment (although I think this is the only way to go because all of the old measures have proven effective).

Geithner announced a cocktail of initiatives using “things we haven’t tried before” and warned “that we will make mistakes.” If the Treasury Secretary is not 100 percent confident in his own plan, how could investors be?

Traders have plowed right back into the US dollar on the fear that the US government is rolling the dice once again. Equities have also fallen as much as 300 points.

The Treasury’s Super TARP plan, which is now renamed as the Financial Stability Plan has 3 core components:

1. More Capital for Healthy Banks

2. New Financing for as Much as $1 trillion of Consumer and Business loans

3. Public Financing for Private Investors Willing to Buy Distressed Debt (details of private/public investment fund have not been released)

Read the rest of this analysis on FX360.com

This post can also be viewed on kathylien.com.

EU Leaves Interest Rates Unchanged In Risky Move

All over the world central banks are dropping key interest rates in an attempt to stimulate lagging economies. Why then would the head of the European Central Bank leave interest rates unchanged despite wide spread economic turmoil among EU countries? Kathy Lien shares her thoughts on Trichet's controversial decision, along with the potential impact to currency markets, in her blog post below.

Here is a snippet of my comments about this morning’s price action on FX360.com:

There has been a lot of action in the currency market this morning, mostly centered on the British pound and Euro.

ECB President Trichet is not buckling under pressure. After leaving interest rates unchanged at 2.00 percent, he refused to make any decisive comments on where interest rates are headed in March. Trichet is still buying time to see how the economy and price pressures respond to their recent rate cuts. The Euro has held steady because Trichet said he is not pre-committing or excluding anything. The zero interest rates that Prof Roubini is calling for is out of the question especially for a central bank that remains obsessed with inflationary pressures. Trichet acknowledged that inflation will continue to fall but he expects it pick up in the second half of the year and if oil prices rebound, the acceleration of price pressures could exacerbate. Rather than being completely downbeat about growth, Trichet said that even though the risks are clearly to the downside, there are signs of stabilization. By postponing rate cuts, Trichet is putting his credibility and reputation on the line.

The ECB cannot stop cutting interest rates at this time especially as we continue to see very weak economic data. German factory orders fell 6.9 percent in the month of December, more than double the market’s forecast. Trichet who is known for his candor has already admitted that 2 percent will not be the lowest level for Eurozone interest rates and the market may be right to bet on a 50bp rate cut in March. If he doesn’t plan to cut interest rates to 1.5 percent next month, he would not comment on the market’s expectations. Although zero interest rates is off the table, we do not think that the ECB will stop at 1.50 percent. Interest rates could fall as low as 1 percent, which is why we could see more weakness in the Euro.

EUR/GBP Crushed After BoE Rate Decision

EUR/GBP collapsed following the Bank of England’s decision to cut interest rates to 1 percent. Even though the yield advantage in EUR/GBP has increased from 50bp to 100bp in the Euro’s favor, the market is less focused on interest rate differentials and more focused on recovery. The pound is trading higher because the Bank of England and the UK are being rewarded for their aggressive monetary and fiscal stimulus. The Euro on the other hand is being punished for implementing sluggish monetary policy.

This post can also be viewed on kathylien.com.

Should The Fed Be Abolished? Ron Paul Thinks So...

This isn't the first time that Ron Paul has brought this measure to abolish the Federal Reserve before Congress, and it probably won't be the last. While most politicians, and Americans for that matter, write Paul off as crazy because of proposals just like this, is he really that offbeat? His arguments seem a lot more powerful now that the economy is struggling so mightily, however, there is still no chance that his legislation will be accepted, at least in his life time. Tim Iacano from The Mess That Greenspan Made talks more about Paul, and his new legislation, in his blog post below.

Earlier this week, Rep. Ron Paul (R-Texas) reintroduced legislation to abolish the Federal Reserve. While it's not likely to go any further than it did last time, efforts like this are an important first step toward making substantive changes in the future:

Madame Speaker, I rise to introduce legislation to restore financial stability to America's economy by abolishing the Federal Reserve. Since the creation of the Federal Reserve, middle and working-class Americans have been victimized by a boom-and-bust monetary policy. In addition, most Americans have suffered a steadily eroding purchasing power because of the Federal Reserve's inflationary policies. This represents a real, if hidden, tax imposed on the American people.

From the Great Depression, to the stagflation of the seventies, to the current economic crisis caused by the housing bubble, every economic downturn suffered by this country over the past century can be traced to Federal Reserve policy. The Fed has followed a consistent policy of flooding the economy with easy money, leading to a misallocation of resources and an artificial "boom" followed by a recession or depression when the Fed-created bubble bursts.

How can you argue with any of this?

While the "lender of last resort" function of the Fed makes a good deal of sense, the "master of the economy" and "master of the money" roles do not.

They never did (unless you're a banker or a politician).

With a stable currency, American exporters will no longer be held hostage to an erratic monetary policy. Stabilizing the currency will also give Americans new incentives to save as they will no longer have to fear inflation eroding their savings. Those members concerned about increasing America's exports or the low rate of savings should be enthusiastic supporters of this legislation.

Though the Federal Reserve policy harms the average American, it benefits those in a position to take advantage of the cycles in monetary policy. The main beneficiaries are those who receive access to artificially inflated money and/or credit before the inflationary effects of the policy impact the entire economy. Federal Reserve policies also benefit big spending politicians who use the inflated currency created by the Fed to hide the true costs of the welfare-warfare state. It is time for Congress to put the interests of the American people ahead of special interests and their own appetite for big government.

Abolishing the Federal Reserve will allow Congress to reassert its constitutional authority over monetary policy. The United States Constitution grants to Congress the authority to coin money and regulate the value of the currency. The Constitution does not give Congress the authority to delegate control over monetary policy to a central bank. Furthermore, the Constitution certainly does not empower the federal government to erode the American standard of living via an inflationary monetary policy.

In fact, Congress' constitutional mandate regarding monetary policy should only permit currency backed by stable commodities such as silver and gold to be used as legal tender. Therefore, abolishing the Federal Reserve and returning to a constitutional system will enable America to return to the type of monetary system envisioned by our nation's founders: one where the value of money is consistent because it is tied to a commodity such as gold. Such a monetary system is the basis of a true freemarket economy.

In conclusion, Mr. Speaker, I urge my colleagues to stand up for working Americans by putting an end to the manipulation of the money supply which erodes Americans' standard of living, enlarges big government, and enriches well-connected elites, by cosponsoring my legislation to abolish the Federal Reserve.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

What Does February Have In Store For Currencies?

January was a great month for the USD, and even better for the Japanese Yen, but what does February have in store for the currency market? Investors should pay close attention as currency expert Kathy Lien attempts to answer that question in her blog post below. Investors should know that past performance doesn't necessarily represent future performance, but it certainly can help investors make educated decisions.

In the beginning of January, I highlighted the effect of seasonality on the EUR/USD. At that time, I talked about how the EUR/USD has a natural bias to sell-off in the first month of the year as investors reverse their year end flows. Since 1997, the EUR/USD has sold off in the month of January 72.7 percent of the time. If we include the currency pair’s price action in 2009, the EUR/USD has now sold off 75 percent of the time in January. The combination of falling interest rates in the Eurozone, recession and a flight to safety into US dollars has led to the strongest January sell-off in the EUR/USD in more than a decade.

February Performance

Now that January is behind us, many forex traders may be wondering if there are any unique characteristics in the currency market for the month of February. Taking a look at more than 30 years worth of data, we have found that on average the trading range in USD/JPY tends to compress in the second month of the year. In fact, of all 12 months, the average trading range in USD/JPY is lowest in February. Lower volatility could mean stability for USD/JPY because high volatility hurts Yen crosses (A Turn in USD/JPY?).

Currency Performance Since January

The final chart (after jump) illustrates how all of the major currencies have performed against the US dollar in January. So far, the Japanese Yen has been the only currency to outperform the greenback.

This post can also be viewed on kathylien.com.

Low Consumer Confidence Pushes Dollar Higher

Consumer confidence fell again, this time to the lowest level on record. Consumers fear the worst, and as a result they are losing all appetite for risk. That means they will be heading for the relative safety of US dollars according to currency expert Kathy Lien. For more insight into how currencies should perform based on the latest report, read Kathy Lien's blog post below.

In more than 40 years, we have never seen US consumers this pessimistic. The Conference Board’s report on consumer confidence fell to 37.7, the lowest level on record. The disappointing consumer confidence report will drag down risk appetite and drive investors into the safety of US dollars. The rally in the US dollar is a reflection of more panic selling and not optimism about US economy. On the heels of the report, we have already seen the EUR/USD and equities turn negative. We may not see a recovery in confidence Until job security is no longer a major concern. Unfortunately with headlines in national papers touting the 74k jobs axed in one day this morning, consumers will not turn optimistic anytime soon. The one silver lining in the report is that we have seen an increase in plans to buy automobiles within the next 6 months. Major discounts are enticing consumers to buy new cars. Looking ahead, discounts and incentives will be the only for businesses to push inventory. Fourth quarter GDP is due for release on Friday and weak consumer confidence supports the market’s belief that growth was the weakest in 26 years.

Earlier this morning, S&P/CaseShiller reported that house prices fell 18.18 percent in the month of November, the largest decline on record. Unfortunately house prices still have room to fall as the labor market remains weak and more inventory floods the market over the next few months.

This post can also be viewed on kathylien.com.

Reviewing The Latest Quarterly Gold Report

Despite the extreme volatility of gold prices, investors continued to dump more money into gold throughout 2008. The latest quarterly gold report shows us some interesting figures and clearly displays that despite the volatility, many investors feel more comfortable holding gold then various other investments. Tim Iacono from The Mess That Greenspan Made takes a closer look at the report and tries to shed some light on the precious metal's up and down performance.

The World Gold Council released their quarterly Gold Investment Digest yesterday and it contained a number of very good charts including the one below that recounts the many financial market crises that drove investors away from other financial assets and into gold.
They noted that the rising price of gold was quite impressive given all the carnage that occurred elsewhere, most equity markets and many other commodities tumbling 40-50 percent or more for the year as the price of gold posted its eighth annual gain, up four percent.

Holdings by the ten gold ETFs around the world climbed to new record highs with another 96 tonnes purchased during the fourth quarter following a whopping 145 tonne addition in the third quarter.

As shown below, the total amount of gold in the ETFs rose to 1190 tonnes by year-end, worth more than $33 billion. Note that the SPDR Gold Shares ETF (NYSEArca:GLD) just added another 13 tonnes yesterday after a three tonne increase on Monday bringing its holdings to 819 tonnes, by far the largest of the bunch.
Elsewhere in the report, mine production was said to be stable, up just two percent overall from a year ago with a number of countries, notably South Africa, experiencing sharp declines. China passed South Africa last year as the world's biggest gold producer.

De-hedging continued but will have a much smaller impact in the future as the total outstanding hedge book now stands at just 526 tonnes. As shown to the right, during the four quarters ending in Q3-2008, miners de-hedged a total of 368 tonnes.

Note that official central bank gold sales dropped sharply, ending up considerably below the 500 tonnes allowed during the fourth year of the Washington Agreement on Gold.

Jewellery demand rose during the third quarter (the most recent quarter for which data is available) and was up modestly on a year-over-year basis, however, the fourth quarter will likely show a big decline due to the worsening worsening economic conditions around the world.

As should be clear in the table, it is the increase in investment demand, not jewellery demand or industrial uses, that supported the gold price in 2008 and this is likely to continue this year.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

What Is Going On In The Forex Market Right Now?

The currency markets have been going crazy lately, with several currency pairs forming new, or close to new, records. With all this volatility what are currency investors to think? Currency expert Kathy Lien attempts to answer this question in her blog post below.

There has been a lot of volatility in the foreign exchange market this morning, driving currencies to historic levels:

GBP/USD - 23 Year Low
USD/JPY - 13 Year Low
NZD/USD - 6 Year Low
EUR/JPY - 6 Year Low
CAD/JPY - 13 Year Low
GBP/JPY - Record Low
NZD/JPY - 8 Year Low

The most significant moves have been in the British pound, which fell to a 23 year low against the US dollar and in USD/JPY, which fell to the lowest level in 13 years. Comments from former Fed Chairman Volcker triggered a wave of risk aversion that led to a technical break in the currency market. He said “we are in serious recession, with no end clearly in sight.” Although there is no question that the US economy is in trouble, by saying that there is no end in sight means that there is no hope which coming from the chairman of Obama’s newly formed Economic Recovery Advisory Board is significant. By saying that he does not an end to the recession is certainly not good advice. Treasury Secretary Nominee Geithner expects an Obama economic stimulus plan to be released in the next few weeks but unfortunately Volcker’s comments overshadowed the prospect of a stimulus plan. Yesterday’s sharp sell-off made investors nervous but Volcker’s comments pushed them over the edge.
We are continuing to see flight to safety into the US dollar and Japanese Yen. Investors are looking to hide in the lowest yielding currencies.

We also had comments from ECB President Trichet and SNB President Hildebrand. Trichet defended the ECB’s monetary policy and said they haven’t decided if 2 percent is the lowest level for rates.

Intervention by Swiss National Bank?

The Swiss franc collapsed after SNB Hildebrand said that the central banks is considering selling francs to halt the currency’s gains. With interest rates already at 0.5 percent, they have no room to ease monetary policy. Therefore they may have to resort to fixed rate currency intervention.

This post can also be viewed on kathylien.com.

Retail Sales Dissapoint: Impact On Dollar

As expected December retail sales disappointed as more consumers cut back spending thanks to the ailing economy. According to currency expert Kathy Lien, the U.S. will likely see very weak fourth quarter GDP numbers which will lead to the USD falling against some major currencies. But some other currencies have major problems of their own that could counteract this latest poor showing from the U.S. economy. See Kathy Lien's full analysis in her blog post below.

For the 6th month in a row, US consumers have cut back spending. The December consumer spending data tells us that retailers had a very tough time this holiday shopping season. Consumers reduced their spending by 2.7 percent but if you take out year end deals in the auto sector, retail sales actually fell 3.1 percent, the largest decline in at least 16 years. The Grinch really stole Christmas this year and no one is happy about it. Lower gasoline prices continued to drive down gas station receipts, but weaker spending was seen across the board. The worry now is that more retailers will be forced to file for bankruptcy protection and the latest consumer spending reinforces those fears. With more than 1 million Americans out of work in the last 2 months, concern about job security lead to more nimble shopping over the Christmas holidays.

Import prices dropped for the fifth month in a row, but by less than the market had expected.

Expect fourth quarter GDP to be very weak. Retail sales is one of the primary inputs to GDP and the sharp drop in consumer spending suggests that GDP could have fallen as much as 4 percent. The dollar should continue to weaken against the Japanese Yen but the Euro has its own host of problems. There are reports that Ireland may call in the IMF if the economy weakens. This is yet another reason why the ECB could cut interest rates on Thursday.

This post can also be viewed on kathylien.com.

U.S. Exports Continue Their Downward Trend

Last year, while the U.S. dollar was down, manufacturers were joyfully experiencing one of the the loan bright spots in the U.S. economy, increased exports. Oh, how things can rapidly change for the worse. The latest trade report showed that U.S. exports were down again, for the fourth consecutive time. Is there any bright spots left in the economy? If so they are hiding pretty well. James Picerno from The Capital Spectator looks closer at the latest trade report in his blog post below.

The trade boom is fading. That's no great surprise, given the weakening state of the global economy. But the slippage in export-related activity comes at an especially challenging moment for the U.S.

Exports remained a bright spot for the U.S. economy last year. As other areas weakened in 2008, the American export machine bucked the trend. It was a timely boost, offering some hope that the approaching recession might be mitigated and perhaps even sidestepped altogether.

The high point came in last year's second quarter, when real (inflation-adjusted) export activity soared 12.3% on an annualized basis while GDP advanced 2.8%. That took some of the sting out of the drop in durable goods spending and a growing sense of unease otherwise in the GDP trend. In the third quarter, the export boom slowed but remained robust, rising 3.0%, in sharp contrast to the 0.5% decline in GDP.

The long-suffering dollar was no small advantage for juicing exports. As the greenback declined, the price cuts on American goods and services became increasingly attractive to foreign countries. Then in July 2008, the dollar began to rally. Although the U.S. Dollar Index has been trading in a range recently, it's still up sharply from its summer lows.

It was a tempting notion to think that exports would save us, although we warned last summer about expecting too much from the trend. "There's a limit to how much economic gain any nation can enjoy through a weakening of its currency," CS wrote in July. "Devaluation may offer short-term benefits, but the U.S. can't devalue its way to prosperity for very long."

The dollar's recent strength at the moment surely isn't helping U.S. exporting activity, nor is the credit crisis or the general economic turmoil blowing through economies around the world. Few analysts expected the fourth quarter GDP report to deliver anything other than a negative number. Today's trade update for November only strengthens that forecast. Exports dropped nearly 5.8% last month, the fourth consecutive montly decline.

No one will be shocked by the trend, although it's a humbling reminder that the economy has nowhere to hide. Employment, consumer spending, and so on have each fallen victim to the ill winds of recession. Exports are no exception. As we discussed on Friday, this is the eye of the economic hurricane and, as a result, all news from the dismal science is likely to be discouraging news for the time being. Not forever, but for a few quarters at least. Time moves slowly when you're waiting for a bottom.

This post can also be viewed on capitalspectator.com.

The Bank Of England Cuts Rates To Record Low

The Bank of England has been around for a long time and weathered many financial storms, but they feel the current storm is so bad that they have cut interest rates to the lowest amount on record. It doesn't appear that the rate cuts will stop there either, currency expert Kathy Lien predicts that more cuts are in the future given the Bank of England's pessimistic tone on the economy. So how will these rate cuts affect the British Pound? Kathy Lien discusses that as well in her blog post below.

As you may now, the Bank of England cut interest rates by 50bp to 1.50 percent, an all time record low for the 300 year old central bank

What I found most interesting about the BoE Monetary Policy Statement is the credit that they are giving to the weak sterling.

“But the substantial depreciation in sterling over recent months may help to moderate the impact on UK net exports of the slowdown in global growth.”

This is one of the arguments that I gave in my 2009 British Pound Outlook about why we expect the UK to be one of the first countries to recovery from the global economic downturn.

As for further rate cuts from the central bank, more is likely given the pessimistic tone of the BoE statement. Inflation is also expected to ease sharply.

However the GBP/USD has broken above the 50-day SMA and entered our buy zone as the rate cut confirms the aggressiveness of the central bank. As long as the currency pair remains above 1.4245 on a closing basis, we could see a move to 1.5585.

source: eSignal

This post can also be viewed on kathylien.com.

Currency Predictions For 2009

All things relating to the economy were crazy in 2008, to say the least, but now that it is over, what does 2009 have in store for us? Currency expert Kathy Lien attempts to look into her crystal ball and determine how the new year will be for the key currencies. Forex investors should make sure to check out her latest blog post below.

2008 has been a crazy year in the foreign exchange markets and hopefully 2009 will bring more steady times for the global economy as a whole. The tremendous amount of fiscal and monetary stimulus that central banks around the world have doled out should begin to have their effect in the second half of the year. Countries that will be the first to rise from the ashes are the ones whose currencies have lost the most value in 2008. In contrast, the countries whose currencies soared will have a much more difficult time recovering.

In 2009, we will be celebrating the 10 year anniversary of the Euro and in January, people around the world will cheer the inauguration of brand new US President. Obama embodies change and hopefully that change will help to pull the US economy out of recession.

Make sure you read my 2009 currency forecasts. I talk about what I expect fundamentally and technically for the following currencies in the year ahead.

US dollar forecast
Euro forecast
British pound forecast
Japanese Yen forecast
Australian dollar forecast
New Zealand dollar forecast
Canadian dollar forecast
Swiss Franc forecast

This post can also be found on kathylien.com.

Strong Dollar: Taking Its Toll On Corporate Earnings

While savers and retirees are excited about the recent strength shown by the U.S. dollar, not everyone is happy about it. Since the dollar has strengthened, corporate earnings have taken a hit, and it is no coincidence. A stronger dollar means that U.S. goods sold overseas all of the sudden become more expensive, and as a result sales suffer. Currency expert Kathy Lien explains this phenomenon in more detail below.

I have spoke often about the consequences of a strong currency. In the case of the US, the weak dollar in the first half of the year has helped to contribute to Q2 and for some Q3 corporate earnings as well. However I strongly believe that Q4 earnings will be very bad. Partly because of the global recession and partly because of the strong US dollar.

There is an article in the Wall Street Journal today titled “Stronger Dollar Cools Sales in Overseas Hot Spots” that talk about this same theme.

But I want to show you their charts on US exports:

Source: WSJ

And now take a look at a chart of the Dollar Index:

Source: Bloomberg

Do you see the correlation?

Also, the strength of the Japanese Yen is a big reason why Toyota is forecasting their first loss in 7 DECADES!!

Source: WSJ

This post can also be viewed on kathylien.com.

U.S. Dollar Rallies, But Will It Last?

The latest jobless claim report came in better than expected, although, while the numbers were better than expected they certainly were not good. Considering everything that is going on in the financial world, though, any time numbers come in better than expected there is a certain exuberance emitted, as people hope that this might be the first sign of recovery. While recovery is not likely anytime soon, it doesn't stop people from hoping. Of the recent announcements affecting the dollar, some have been good, while others have been bad. Currency expert Kathy Lien evaluates the impact of these recent happenings on the U.S. dollar in her blog post below.

Here’s a snippet from my Daily Currency Focus on GFTforex.com

After seeing the US dollar sell off for 5 straight days against the Euro and Japanese Yen, we were not entirely surprised to see today’s recovery, especially on the heels of better than expected economic data. The market has become accustomed to disappointments so good news was a welcome change. The European Central Bank has also reduced the interest rate that it offers to banks that deposit with them in order to encourage lending. The 15 percent rally in the Euro has led many to people to believe that the ECB may reconsider their plan to hold interest rates steady in January and the deposit rate cut was seen as a step in that direction. Thin market conditions near the holidays have exacerbated the volatility in the currency market. However even though the greenback is higher today, we had both positive and negative news impacting the dollar.

The Good News: Better Data, Oil at $36, More Stimulus on the Way

The Philly Fed index and jobless claims were better than expected, but the improvements still masked underlying weakness. New orders singlehandedly drove the Philly Fed index higher as sharp deteriorations were seen in the other 8 subcomponents. Even though the number of people claiming unemployment benefits still rose by more than 500k last week, the rise was less than the previous period, which suggests that the hemorrhaging in the labor market is slowing. However that has not stopped weekly claims from hitting a new high. There was also news that Obama’s economic team is looking to push through a stimulus package worth up $775B over the next two years. This package should play a big role in helping to turn the US economy around. Oil prices have also fallen to a 4 year low of $36 a barrel, which represents a 75 percent decline from its record high. In may not be long before we see gasoline prices at $1.50 a gallon. Lower oil prices acts as a tax cut for consumers and should help to improve consumer spending.

The Bad News: GE AAA Rating at Risk, Pessimistic Comments from Fed Official

Aside from the fact that the good news masked underlying weakness, more worrisome reports have hit the corporate sector. Leading indicators fell to the lowest level in 4 years on the back of a sharp rise in jobless claims and decline in US equities. Standard & Poor’s revised General Electric’s rating outlook from stable to negative, which suggests that GE’s AAA credit rating may be at risk. A company’s credit rating is directly tied to their cost of borrowing and their overall health. GE’s problems center on their financial unit which was hit hard by the credit crisis. All Big 3 automakers have also announced that they will idle a number of their plants over the next month, reflecting the severity of their financial situation.

Despite the recent rate cut, Fed officials remain very pessimistic about the outlook for the US economy. Fed President Fisher expects the US economy to continue to contract in 2009, driving the unemployment rate past 8%. Having leaned towards hawkishness in the past, Fisher’s dovish comments are particularly alarming. However Greenspan expects the economy to rebound in 6 to 12 months, but of course he is no longer involved in US monetary policy.

This post can also be viewed at kathylien.com.

Looking Ahead To The Bubble Of Tomorrow

As we deal with the consequences of the current asset bubbles popping around us, it is hard to give any thought to future bubbles. However, considering all the recent moves that the government has made, we really do need to pay attention to what their ramifications will be. The things that the government has done are unprecedented, and we should expect the next round of bubbles to be the same. James Picerno from The Capital Spectator talks more in depth about this in his blog post below.

Governments are now working overtime in dispensing monetary and fiscal medicines intended to renew, restore and revive battered economies. In time the aid will quicken the economic heartbeat, although exactly when and to what degree is unknown. The patient has for years gorged on any number of goodies, ranging from the sweet treats of leverage and the candied delights of easy money to roller-coaster thrills of irrational investing.

The party, of course, is over, and the cleanup may go on for some time—probably longer than we expect. In a somewhat haphazard and increasingly desperate effort to ease the current and future pain, governments are dishing out unprecedented rounds of stimulus pills. For obvious reasons, everyone's watching each new step in what promises to be a long run of conventional and unconventional programs intent on propping up economies from east to west, north and south and everywhere in between.

But while the lion's share of attention is on the medicines, what might follow once the patient is no longer in imminent danger of cardiac arrest? In a speculative exercise of considering the possibilities, we offer the following thoughts for the post-crisis world order, which one day will arrive, amazing as it seems at the moment.

* Inflation
Yes, inflation. Strange as it sounds to talk about inflation at a time when deflation seems to be stalking the U.S. economy, it's never too early to think about the natural state of economic affairs. One day (don't ask us when), all this stimulus and its baggage will be yours. Pulling back on the sea of money washing ashore will eventually require the mother of all mopping-up campaigns. Assuming, of course, the Fed and central banks around the world have the stomach for the task.

Make no mistake: pulling back will be tough, very tough. Imagine the scenario a year from now. Let's make a big assumption and say that the economy's showing signs of life and GDP manages to post a modest 1% rise in Q4 2009, with more of the same expected for 2010. Higher interest rates would certainly be warranted, relative to the near-zero levels of the moment. Perhaps much higher rates will be required. But will Bernanke and the boys be willing and able?

The political pressure to keep the stimulus going will probably be immense. Meanwhile, warnings of higher inflation at some point are likely to fall on deaf ears for an extended period. Higher inflation, after all, is just what the Fed wanted by lowering rates so low and so arguments for containing the revival in prices will initially dismissed.

Yes, the inflation beast will work his way back into the director's chair. He always does, and he has a thousand tricks up his sleeve. His task will be all the easier if the deflation mindset takes root, which looks increasingly possible.

Nonetheless, some corners of finance are worried about the longer-term risks. That includes the dollar sellers and the gold buyers. Yes, deflation is a risk, but in the long run history tells us that inflation always comes out on top eventually.

What's more, a sudden change in the weather is hardly beyond the pale. Recall that inflation worries were all the rage earlier this year. Yet that fear quickly gave way to deflation. Expecting smooth and gradual changes on the pricing front may be asking for too much in the 21st century.

* Oil
Just as inflation worries have been banished in recent months, so too are the headline-grabbing predictions of $200 oil. These days, that's a forecast with one too many zeroes.

But let's be clear: the recession-inducing fears that are pushing oil lower these days will eventually abate. That doesn't mean oil will suddenly resume its skyward run at the first sign of economic stability. But marginal growth in oil demand isn't dead; it's merely hibernating.

China, India, and, yes, the United States will one day be in need of more oil. Yes, green technology will slow future demand for fossil fuels. But unless you're expecting miracles, the world economy will almost certainly be consuming more oil in 3 to 5 years compared with today. The crowd, however, will be focused on demand trends over the next year or two and thereby conclude that high oil prices are forever gone. Oil companies will be pressured into agreeing, resulting in a sharp decline in searching for and developing new oil fields. Those are the seeds that will push prices higher once more, perhaps to new all-time heights, although probably not for several years.

* The Bubble of 2013?
No one knows where all the stimulus will wind up, but there are pretty good odds (and a fair amount of historical precedent) suggesting that exuberance will eventually reanimate itself with all its immoderate excess intact. Some say that Treasuries are now a bubble waiting to burst, courtesy of interest rates that can only go higher from here. Perhaps, although it's a safe bet that one day, perhaps sooner than we expect, bubble sightings will return.

Bubbles, writes John Kemp of Reuters, are no accident. "It is the direct consequence of the Fed's asymmetric response to shifts in asset prices." Much will depend on whether the reflation policy is, at the appropriate time, wound up and put in the closet. In theory, it's a no-brainer. In practice, there are complications.

Finally, we bring all this up mainly as a reminder that it's always difficult to maintain strategic perspective. Two years ago, when all the major asset classes were rising, few could imagine the current pain of the moment. Similarly, looking at where we're headed several years from now looks about as relevant as studying the moons of Saturn. But the future keeps coming, even if we're not looking. It's tempting to make all our investment decisions based on what happened yesterday, but we're all probably better off keeping our strategic-investing focus on what's likely to unfold several years from now. No easy task, to be sure. Par for the course if you're intent on winning the investment game.

This post can also be viewed on capitalspectator.com.

Flurry Of Fed Moves Could Lead To Hyper Inflation

In what was a surprising move yesterday, the Fed dropped the Fed funds rate basically to zero, surpassing market expectations. Everyone fears deflation, and the Fed is willing to do whatever it takes to avoid it. But as Toni Straka from The Prudent Investor points out, these drastic moves could soon lead us to hyper inflation.

Share and bond markets rallied on Tuesday after the Federal Reserve announced that it will give away new money for almost free, lowering the Fed Funds target range to a historical low of 0% to 0.25%. The Fed had cut the Fed Funds rate in late October by 50 basis points. The new record low rate is a reaction to to the de facto status quo in treasury securities where short maturities of up to 6 months trade at yields below the upper end of the target range.

In a most unusual move the Fed provided publishable background on its decision, writes the WSJ blog, detailing it all here. The Fed has not held press briefings until now.

While markets welcomed the bold move, gold, the canary in the mine of inflation, advanced as well, piercing the important resistance at $850. Investors are obviously pricing in that all Treasuries yield less than the inflation rate of currently 3.7% YOY.

But the move to a zero interest rate policy will come at the cost of higher inflation in 2009 and 2010, it can be safely predicted. Chairman Ben Bernanke and his fellow Federal Open Market Committee (FOMC) members pulled out all stops in order to jumpstart the economy and assured market participants that the Fed would continue to engage in the dubious game of printing fresh money for collateral it does not want to talk about.

Once more proving their image of inflationistas par excellence the FOMC said the Fed can be expected to hold on to its free money policy for quite some time and use all tools to promote a return to growth.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

But money for nothing alone will not help, the Fed reasoned, preparing markets for more growth in the Fed's balance sheet after it has exploded from $800 billion to $2.2 trillion since last summer. Expect the Fed to continue to buy more worthless MBS (mortgage backed securities) while substituting the banking sector in the commercial paper market.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

I translate this into "we will throw (fiat) money (that costs us next to nothing) on every problem as we did in the past 2 decades." See more worthless money created that will be exchanged for more MBS that are valued on a theoretical basis, i.e. not the market price which may be only a tiny fraction of the initial face value.

The announcement that the Fed is looking into buying longer term US Tresuries raises immediate fears that the Fed will be monetizing the federal debt again after a portfolio shift towards MBS in the recent past. Any talk about deflation misses the point of unprecedented monetary inflation that will show up in the real economy 2009/10.

Eric de Carbonnel argues at DollarDaze that monetary inflation does not even have to pump up money supply - my favorite theory - but that it is a loss of confidence that increases the velocity of money, resulting in the dange of hyper inflation.

The record low official Fed Funds rate may be elusive though. Jake at EconomPicData sees a disconnect between municipal bonds and Treasuries, reflecting the horrendous outlook for cash strapped communities which had invested heavily in property debt. Now they are broke.

GRAPH: The yield spread between Munis and 5-year Treasuries soared to a record high of 325 basis points. Graph courtesy of EconomPicData.

DollarDaze draws a historical comparison that shows deflation can be a hazy illusion.

As an example of deflation leading to hyperinflation, consider the case of the Weimar Republic. In 1920, Germany experienced a deflationary collapse, with the average citizen finding it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks, and businesses were strapped for cash to buy materials and meet payroll. Fearing a collapse that would throw millions of workers out on the street, the German government desperately printed money in an attempt to re-inflate the economy. During this period, despite the government's money printing, the mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%.

Eventually, as a result of the money supply's rapid expansion, the nation's massive foreign debt, and the shrinking economy, German citizens lost all confidence in their currency, and the Weimar Republic experienced one of the worst cases of hyperinflation in modern economic history.

Check out the time series of the Weimar hyper inflation - with the interim "correction" before it went parabolic - here.

The new policy to lend money to banks for free shows that the Fed is obviously willing to monetize all debt problems that come along. With its seven new financing tools introduced since the beginning of the crisis in August 2007 the Fed is already intervening in MBS markets and tries to keep the commercial paper market afloat.

But after all these attempts are nothing more than new fiat money with a different ribbon. The road to hyper inflation is clearly visible as were most problems already more than 3 years ago.
Time will show whether the Fed has been correct in its view of current conditions. Taking it from the past 15 months the Fed has been behind the curve despite its fast moves. It is to be doubted that the increasing readiness to prop up all markets with new money will mitigate the crisis. It will rather delay it but the point of no return comes closer with every day. Central banks have a bad record of containing inflation once they set the process into motion willingly.

But these facilities have not brought the liquefying effect the Fed had hoped for. So far all attempts to revive credit markets have failed, observes not only Bloomberg, which has all the details on Tuesday's rate decision.

This post can also be viewed on prudentinvestor.blogspot.com.

The Next Big Bubble To Burst: U.S. Treasuries

Everyone in the world knows that the U.S. has a huge debt, and that the U.S. economy is performing poorly. Yet, people are flocking to U.S. treasuries like never before driving yields down to record lows. The U.S. has no plans of stopping the debt train, though, so who knows how high it will go. We are on uncharted ground right now, and all it would take to push this train off the tracks is one major debt holder to start selling. Lots of other bubbles have burst recently, so why not possibly the biggest one of all? Needless to say if this happens there will be serious ramifications for the U.S. and the rest of the world, which is probably why it hasn't happened already. Toni Straka from The Prudent Investor looks closer at this looming problem in his blog post below.

Having seen most of the bubbles bursting I had listed in this post from 2005 the world may soon be in for the mother of all bubbles. With a size of $10 trillion the US government debt market has remained the world's #1, now that MBS have shed the better part of their initial values.

US treasuries have long been hailed as a safe haven for money fleeing from other overheated markets. Massive losses in more or less all other asset classes in the past 15 months have shown that investors followed Pavlov's reflexes, driving the 10-year yield to a record low of 2.55% last week.

CHART: The yield for 10-year US Treasury debt fell to a record low of 2.55% last week. This chart may see a sudden reversal based on the fundamentals.

It may be questioned whether this trust into the Federal Reserve's ability to contain long term inflation is justified, given the fact that chairman Ben Bernanke will enter history as the fastest money printer of all times.

While the Fed has reduced its federal debt holdings by $290 billion to $484 billion (buying doubtful MBS instead) in the last 12 months it was foreign investors TIC data and Treasury statistics show.

This has driven yields across the curve to record lows, leaving investors with a negative real yield when discounting inflation. US Inflation was 3.7% YOY as of October.

Institutional investors have been allocating more money into US treasuries recently, citing the safe haven status of American government bonds. But this era may be coming to an end as so many things do nowadays.

There appears to be a split of opinion. While European and American investors follow the old rule of buying US debt with a questionnable AAA rating their Asian counterparts see themselves trapped with US debt holdings they cannot sell in order to avoid a panicky stampede out of the biggest market of all.

The deficit outlook justifies a skeptical approach. Barack Obama will have to finance a budget deficit of an estimated $1 trillion in 2009, the biggest in American history. If Mr. Obama will not manage a U-turn in foreign policy which was mainly based on ignorance and arrogance under Bush, he could run into financing problems. China has urged other countries to replace Federal Reserve Notes with their own currencies in bilateral trade and voiced its concern about US fiscal policy repeatedly.

The global downturn may bring a different borrowing climate too. Losses in all asset classes across the board and record low yields will result in lower reinvestment amounts overall, it can be safely projected.
The borrowing needs will skyrocket as both the federal government and bankrupt local communities will scramble for funds to replace sudden drops in tax revenues.

Bets On A US Default Become More Expensive
While still being a mainstay for investors from all around the world, not everybody is confident about the future of a USA in the grip from the biggest financial crisis ever. Some wary souls are increasingly buying insurance against a default of the US government. According to a Reuters report from November 26, credit default swaps involving Treasuries reached a record high.

Ten-year U.S. Treasury CDS widened to 54.7 basis points from Tuesday's close of 50.0 basis points, credit data company CMA DataVision said.
Five-year Treasury CDS jumped to a record 52.0 basis points from Tuesday's close of 47.50 basis points, it said.

In plain language this means investors were willing to pay $54,700 to insure a portfolio of $10 million 10-year debt paper.

Summarizing the fundamentals such as no end to new debts, tax shortfalls, higher social and military expenditures, a central bank willing to monetize the debt and flooding the world with fresh Federal Reserve Notes, it can be safely bet that this bubble will end like all bubbles: In a gigantic burst that will unsettle everything we have learned about investing in the past.

A hat tip to Econbrowser who undug this paper by Stanford economics professor John Taylor on the failures of the Fed in the current crisis and why it all became worse this autumn.

I stand by my opinion that monetary inflation is in the early stages worldwide and will have seeped through into the real economy in 2009/10.

This article has been reposted from The Prudent Investor. The full post can also be viewed on The Prudent Investor.

U.S. Debt Offerings: The Biggest Ponzi Scheme In History?

The U.S. Treasury has not been able to keep up with the monetary demands from the Fed which lead them to request the authority to print their own debt. In what has to be considered a ridiculous run up in the national debt of late, this move just compounds the potential problems. This is leading some people to question the validity of U.S. sovereign debt. Is the U.S. government running the biggest ponzi scheme in history? It sure seems like it. Toni Straka from The Prudent Investor looks closer at this in his blog post below.

Ladies and gentleman, fasten your seat belts in anticipation of more monetary madness. In its drive to keep the helicopters above Wall Street (and certain privileged corporate headquarters) filled with colourful stacks of fiat money that can be showered onto everybody that is deemed too big to fail the Federal Reserve blueprints a new layer of debt, writes the Wall Street Journal on Wednesday.

According to the story based on sources "familiar with the matter" the Fed considers to issue its own debt. This would allow the Fed to circumvent banks as intermediaries, possibly leading to a recovery of capital markets. But it could also lead to a situation where the Fed would be a direct competitor to the US Treasury in debt issuance.

While the privately owned Fed's right to print unbacked fiat money is already constitutionally doubtful (see my sidebar) even the Federal Reserve Act does not explicitly permit the Fed to issue debt either.

As chairman Ben Bernanke religiously follows a policy of the easiest money ever in order to combat what will become a bigger depression than the 1930s Ben is looking into new ways to drop Federal Reserve Notes all over the world.


Always remember that chairman Ben Bernanke has become the biggest and fastest money printer in the history of mankind by now, doubling the monetary base within a week. It took 95 years for the first 750 billion. Ben added the same amount last November.

The WSJ reasons that the Fed has to make a move because of the explosive growth of its balance sheet and the questionnable quality of its collateral.

What the WSJ does not ask is whether the continuation of the game of unlimited funny money is another desperate attempt to keep the biggest Ponzi scheme of all times running a little longer. Without ever expanding credit the whole FRN scheme is destined to fail as did ALL other unbacked fiat currencies before.

From the WSJ:

The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

...Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.
It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency.

Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.

At the core of the deliberations is the Fed's balance sheet, which has grown from less than $900 billion to more than $2 trillion since August as it backstops new markets like commercial paper, money-market funds, mortgage-backed securities and ailing companies such as American International Group Inc.

The ballooning balance sheet is presenting complications for the Fed. In the early stages of the crisis, officials funded their programs by drawing down on holdings of Treasury bonds, using the proceeds to finance new programs. Officials don't want that stockpile to get too low. It now is about $476 billion, with some of that amount already tied up in other programs.

The Fed also has turned to the Treasury Department for cash. Treasury has issued debt, leaving the proceeds on deposit with the Fed for the central bank to use as it chose. But the Treasury said in November it was scaling back that effort. The Treasury is undertaking its own massive borrowing program and faces legal limits on how much it can borrow.

More recently, the Fed has funded programs by flooding the financial system with money it created itself -- known in central-banking circles as bank reserves -- and has used the money to make loans and purchase assets.

Some economists worry about the consequences of this approach. Fed officials could find it challenging to remove the cash from the system once markets stabilize and the economy improves. It's not a problem now, but if they're too slow to act later it can cause inflation.
Moreover, the flood of additional cash makes it harder for Fed officials to maintain interest rates at their desired level. The fed-funds rate, an overnight borrowing rate between banks, has fallen consistently below the Fed's 1% target. It is expected to reduce that target next week.

...There are also questions about the Fed's authority.

"I had always worked under the assumption that the Federal Reserve couldn't issue debt," said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. He says it is an action better suited to the Treasury Department, which has clear congressional authority to borrow on behalf of the government.

I conclude the Fed is looking for ways to fuel future monetary hyper inflation in truly creative ways. This move comes only 2 months after the Fed had announced unlimited FRN refinancing in collaboration with other major central banks.

Bernanke is of the stubborn opinion that the last depression was a result of too tight monetary policy. While this may be true to a certain extent we have no reality based example that a zero interest rate policy has helped averting an economic downturn that stemmed from too much easy money in the first place. It was the Fed that refused to recognize the unsustainable property bubble. It appears this was not their first mistake and it will not be their last one.

This article has been reposted from The Prudent Investor. The full post can also be viewed on The Prudent Investor.

Here Come More Interest Rate Cuts

Central banks from around the world are cutting interest rates in dramatic fashion in an attempt to curtail the financial crisis. If these record interest rate cuts will help remains to be seen, but it seems that the world's central bankers feel it is their best hope. Tim Iacono from The Mess That Greenspan made talks more about these rate cuts in his blog post below.

Now's not the time to be timid if you're a central banker or an elected official. Day after day they watch a once vibrant world economy sink deeper into an abyss caused by a massive credit contraction following the collapse of multiple asset bubbles.

Central banks all around the world were busy today slashing interest rates with abandon:

• Bank of England -------------- cut 100 basis points to 2.0 percent
• European Central Bank -- cut 75 basis points to 2.5 percent
• Sweden's Riksbank ---------- cut 175 basis points to 2.0 percent
• Bank of New Zealand ------- cut 150 basis points to 5.0 percent
• Bank of Indonesia ------------ cut 25 basis points to 9.25 percent
  

Earlier in the week, Australia's central bank cut short-term interest rates by 100 basis points to 4.0 percent and Thailand slashed by a full percentage point.

Tumbling home prices and a rapidly weakening economy have created a near state of panic in the U.K. that makes the situation in the U.S. somehow look tame by comparison. Short term rates have fallen by 300 basis points in less than two months and they now sit at their lowest level since 1951.

On the continent, the fifteen countries that use the euro got their biggest interest rate cut in the common currency's 10-year history as the central bank attempts to mop up after collapsing housing bubbles in Spain and Ireland while also dealing with major economic slowdowns in Germany and Italy. The French just announced a $33 billion stimulus package.

Herding cats has never been more difficult.

The Swedish central bank couldn't wait for their regularly scheduled mid-December meeting and hastily made their biggest rate cut in 16 years in an attempt to combat a recession that officially began two months ago. The government also announced a $4 billion stimulus plan.

In New Zealand, rates were slashed by a record 1.5 percentage points and Reserve Bank Governor Alan Bollard indicated there are more, smaller cuts to come. The kiwis entered a recession back in the first quarter of the year and short-term rates have been slashed from 8.25 percent over the summer to just 5.0 percent.

In Indonesia, both interest rates and inflation (~12%) are still quite high and the central bank has received some criticism for making its first rate cut in over a year. They were no doubt influenced by the full-point rate cut in Thailand a few days ago.

The day is still young - there may be more rate cuts to come.

This article has been reposted from The Mess That Greenspan Made. The full post can also be viewed on The Mess That Greenspan Made.

Recession Impact On The U.S. Dollar

So how does the dollar react during a recession? You might be surprised by the consistency of its performance during recessions, but then again this recession is a little different than those of the past. Currency expert Kathy Lien looks at the historical trend and offers some insight in her blog post below.

There has been 3 recessions in the past 30 years. In each of those recessions, the dollar weakened in the first six months of the recession, then gained strength in the next six. Twelve months into the current recession, we see this pattern in the dollar repeated once again.

The more important question however 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, there could be a near term top in the US dollar in the first half of 2009. There were 2 separate recessions in the 1980s and according to the dollar index chart below, in each recession, a sharp dollar rally was followed by a sharp correction.

The space between the purple lines represent the 2 separate recessions. Even though the dollar rally did eventually continue, it was not before a meaningful correction.

I wouldn’t be surprised to see this happen again especially as the strong dollar takes a bite out of corporate earnings in the first or second quarter of 2009.

This article has been reposted from Kathy Lien. The full post can also be viewed on KathyLien.com.

Interest Rate Cut Expectations From Around The World

So which country will be the first to drop interest rates to zero? Japan has a head start, but they are not expected to drop interest rates at their next meeting. The U.S. on the other hand is expected to drop their Fed Funds rate down to 0.5 percent, and could very well win the race to zero, if things don't turn around soon for the economy. Kathy Lien looks closer at interest rates around the world and shares her expectations on how future cuts might pan out.

With the global economic downturn in full swing, one of the burning questions on everyone’s minds is who will be the first central bank to take interest rates to zero and how close will everyone else get?

We are in a global easing cycle and the varying aggressiveness of central banks around the world means that any country could be the first to see zero interest rates.

We expect December to be another active month for the foreign exchange market as central banks around the world take their interest rates to historically significant levels. There are 4 central banks with monetary policy decisions in the first week of December and all 4 are expected to cut interest rates. The closest to zero is the Bank of Japan, but having been there before, they are reluctant to revisit those levels. The US Federal Reserve and the Swiss National Bank have the second lowest interest rates. Both central banks are expected to continue to ease, but the Fed has been far more open about going to zero interest rates than the SNB. Realistically, Japan and the US will probably be the only ones to take rates all the way down to zero. Switzerland should be left with the second lowest interest rate when the dust settles followed by the Bank of England.

What Happens After Zero?
When a central bank runs out of room to cut interest rates, they resort to Quantitative Easing. This term was coined by the Bank of Japan in 2001 when interest rates were already at zero and the central bank stopped targeting the overnight call rate and turned to targeting a current account level. Their goal was to flood the Japanese financial system with liquidity by buying trillions of yen of financial securities including asset-backed instruments and equities.

It can be argued that the US has already engaged in Quantitative Easing as the government has recently announce plans to spend $800 billion to unfreeze the consumer and mortgage market. They have agreed to buy mortgage backed securities backed by government sponsored entities and could accelerate that if interest rates hit zero. Excess reserves have also increased significantly, driving the effective fed funds rate well below 0.5 percent. This would have been one of desired outcomes of quantitative easing. Last week, Fed vice chairman Donald Kohn said quantitative easing measures were under review at the central bank as normal contingency planning. The goal would be to encourage banks to lend more aggressively by coming in as a buyer at specified rates. Even though quantitative easing drove Japan into deflation, it was the key to turning around the economy and this is a risk that the US central bank may have to take.

Here’s where the major central banks stand and what is expected for the next meeting:

Federal Reserve – 50bp Cut Expected on 12/16

On October 29, the Federal Reserve took interest rates to 1 percent, which is near the record low reached in 2003 and 2004. While other countries have just started reacting aggressively to financial conditions, the Fed has been mounting cuts as far back as the middle of 2007. There has been no looking back since, as rates have been cut 425bp since 2007 and 250bp year to date. With interest rates near ultra low levels, the Federal Reserve has already resorted to unorthodox policy tools. More easing is expected with the markets torn between a 50 or 75bp rate cut in December. The FOMC statement will be particularly important this time around because the Fed will have the difficult decision of signaling a move to zero interest rates. In order to deal with this decision, they have expanded their monetary policy meeting from 1 to 2 days. Fed Chairman Ben Bernanke has remained dovish throughout the past few months which mean that another rate cut is practically guaranteed.

European Central Bank – 50bp Cut Expected on 12/04

On November 6, the European Central Bank cut interest rates by 50bp to 3.25 percent. The European Central Bank has abandoned their old monetary policy metric in the previous months, opting for a more growth-concentrated approach to interest rate decisions. Such a change has accompanied a round of rate cuts that has brought the target rate down to 3.25%. ECB President Trichet has made no indication that rate cuts would stop here. However, in relation to neighboring nations, the ECB has not acted as aggressively, dropping rates only by 75bp this year. Compared to a year to date cut of 250bp by the US and 225bp by the UK, the ECB seems to be lagging behind the curve. Now that the region has officially hit a recession, it is possible that they will be more aggressive in easing rates. The ECB has the power to organize a continuous program of such policy implementation since their target rate is one of the highest, outside of Australia and New Zealand. The only factor holding them back is inflation pressures. Although producer and consumer prices have been easing, the central bank is not entirely convinced that the upside risks to prices have alleviated.

Bank of England – 100bp Cut Expected on 12/04

The Bank of England has been the most aggressive and proactive of the G-10 central banks in their attempts to ease monetary policy. The most recent cut of 150bp was a huge surprise to all traders and represents the largest single meeting cut to occur for any of the major central banks during the financial crisis. However what was even more shocking was the fact that the minutes from the most recent monetary policy meeting in early November suggested that they considered an even larger interest rate cut. Going into the December monetary policy decision, the market expects the BoE to ease by another 100bp. With the economy in a recession according to UK officials, interest rates could fall as low as 1% if the crisis continues well into the New Year. The BoE’s ability to cut by such a sizable amount was also reflected in the fact that inflation, once the primary concern, has eased considerably in the last few months. In addition to monetary stimulus, the UK government has been at the forefront of bank bailouts and fiscal stimulus.

Bank of Japan – No Rate Cut Expected on 12/19

After cutting interest rates by 20bp last month’s meeting, the Bank of Japan left interest rates unchanged in November. It is unlikely that we will see much more easing as officials have expressed a certain sense of reluctance in bringing rates back to zero. The Japanese are all too familiar with the implications of such rates and will be forced to look for new methods to ease the financial strain on the country. Masaaki Shirakawa, the BoJ Chairman, informed the Bank’s staff to, “swiftly examine and report possible changes in the treatment of corporate debt as collateral, as well as possible ways to enhance flexibility in funds-supplying operations collateralized by corporate debt.” Such statement seem to indicate that, while we will unlikely see much in the way of new rate cuts, we will see new initiatives that focus on shoring up lending and improving liquidity.

Bank of Canada – 50bp Cut Expected on 12/09

On October 21, the Bank of Canada cut interest rates by 25bp to 2.25 percent, the lowest level since October 2004. Although the size of the rate cut was smaller than the market had anticipated, the BoC had already cut interest rates by 50bp on October 8th. Mark Carney, the Governor of the Bank of Canada, has been very vocal in explaining his thoughts on the health of the Canadian economy. Carney comments can be summed up in this statement, “the risks to growth and inflation in Canada appear to have shifted to the downside…some further monetary stimulus will likely be required to achieve the inflation target over the medium term.” We can rarely expect such a “cut and dry” statement from a central bank official. He leaves little to question. However, he does note that the economy does have some strong areas, specifically domestic demand (retail sales rose 1.1 percent in the month of September). The BoC governor also noted that the weakness in the Canadian dollar has picked up some slack from the declines in international demand. The market expects the central bank to ease interest rates by another 50bp at the next meeting, which would take rates down to 1.75 percent. Canadian interest rates have not been below 2 percent since the 1960.

Reserve Bank of Australia -100bp Cut Expected on 12/02

The Reserve Bank of Australia has definitely not sat idly by watching its economy deteriorate. Along with 175bp of easing this year, the central bank has also resorted to intervening in the currency markets to support its currency. Intervention has been a very controversial monetary tactic because it simply does not have a good record. However, such desperation does indicate that the bank is having a tough time dealing with the consequences of rate cuts. A target rate of 5.25 percent leaves the RBA with plenty of opportunity for additional easing in the future. However, the RBA minutes explain that the 75bp cut made at the last meeting would be necessary in that “there was an advantage in moving the setting of monetary policy quickly to a neutral position.” Regardless of such a statement, the market still believes that the RBA will cut interest rates by 100 to 125bp at the December meeting.

Reserve Bank of New Zealand – 150bp Cut Expected on 12/03

The Reserve Bank of New Zealand cut interest rates rates by a full percentage point in October, citing “ongoing financial market turmoil and a deteriorating outlook for global growth. In a statement published in an article released by the RBNZ, the bank notes that “global developments have proven extremely disruptive and it will likely be some time before financial market conditions normalize. The Bank will continue to adopt measures as needed to maintain the stability of our financial system as far as possible in these difficult times.”Once again we see some very dovish statements made explicitly from central banks. The recession embattled country has plenty of ammunition as rates are at the very high level of 6.50%. While zero percent interest rates may not be a possibility, it is possible that we will be surprised by some extremely aggressive cuts. The market currently expects the RBNZ to cut as much as 1.5 percentage points in December and eventually take interest rates down to 5 percent. It is also important to note that rates have not fallen below 4.50% in the last ten years.

Swiss National Bank – 50bp Cut Expected on 12/11

The Swiss National Bank surprised the market by delivering a full percentage point intermeeting rate cut. Citing the obvious fact that international economic conditions have worsened, the central bank made its largest one day rate change in eight years. The economy has weakened substantially due to the fact they have a large exposure to the banking sector. The Swiss National Bank hopes that the move will provide the market with a generous and flexible supply of liquidity. The bank’s continuous issuance of surprise rate decisions leads us to believe that more can be expected. Many economists expect the SNB to continue cutting interest rates to 0.5 percent.

This article has been reposted from Kathy Lien. The full post can also be viewed on KathyLien.com.

British Pound Due For A Pounding

Last week the Bank of England surprised everyone by cutting their key interest rate by 1.5 percent. With their economy still struggling it seems like the rate cuts won't likely stop there either. This will have serious implications on the value of the British pound. Currency expert Kathy Lien evaluates the situation in her blog post below.

When the Bank of England cut interest rates by 150bp last week, I turned aggressively bullish EUR/GBP on the belief that interest rates are headed below 2%. The currency pair has now hit a record high as the market realizes that not only will UK interest rates fall below 2%, but could be headed to Japanese levels. Against the dollar, the British pound has fallen to fresh 6 year lows but the historically significant moves are in EUR/GBP.

According to the November Inflation Report, the monetary policy committee believes that inflation will fall below their 2 percent target with the potential of hitting 1 percent. With price pressures expected to ease significantly, the Bank of England sending a strong signal that interest rates will continue to come down.

There is talk that the recessionary conditions in the UK economy could turn the UK into the next Japan. Another 200bp of easing by the end of the first quarter has been priced into the markets, which would take interest rates to 1%. If the BoE chooses to overshoot monetary stimulus, UK interest rates could be at Japanese levels.

Mervyn King has become quite a maverick and we would not be surprised to see another large rate cut from the central bank.

When the dust settles, the UK’s aggressive monetary stimulus should turn their economy around faster than the Eurozone or the US, but in the meantime, more rate cuts mean more weakness for the British pound.

This article has been reposted from Kathy Lien. The full post can also be viewed on KathyLien.com.

China's Bailout Hype Fizzles

It seems everyone was excited about the news of China's bailout for their financial system, however, that excitement was short lived. Kathy Lien points out in her blog post below that investors had simply pinned too much hope on China. Kathy also makes recommendations on currency trades that should do well in the current recession.

US equities turned as traders realize that everyone is pinning too much hope on China. The reality is that China’s stimulus plan will not save the global financial and economic crisis. Instead, the only thing that is assured is that at one fifth of 2007 GDP, China will have less money to spend on financing the US’ current account deficit.

China: Not the Answer to Everyone’s Problems

Every country is doing their best at stimulating domestic growth and that is exactly what China is focused on right now. Their priorities are at home and not abroad and their plans to invest in low-rent housing, infrastructure, rebuilding programs and tax breaks on capital spending are aimed at helping their economy cool at a more manageable pace. However it is not a bailout for the financial market and will not be enough to stimulate global growth. Some foreign manufacturing and construction companies will benefit from China’s investment in infrastructure, but the bottom line is that like the rest of the plans announced by developed governments, it shifts and not creates wealth. We also don’t think that it is a coincidence that China made its announcement ahead of a busy data week that will surely confirm the continued weakness in the Chinese economy. With a need to focus domestically, Chinese demand for dollar denominated investments will decrease, especially after some particularly nasty losses incurred at the Sovereign Wealth Fund.

Will there be Fireworks at the November 15 Meeting?

World leaders will be headed to Washington for the Economic Summit on November 14 and 15. The hope is that we will see more detailed proposals on dealing with the economic crisis. Unfortunately as the date nears, investors are starting to realize that no substantial changes may come out of the meeting. With a little more than 2 months before the leadership changes in the US, the current administration may not want to commit to any major policy changes. But if they do, that is exactly what can turn the financial markets around (US President-elect Barack Obama has announced that he will not be attending the financial Summit). Although G20 finance ministers and central bankers pledged to jointly tackle the global financial crisis at this weekend’s G20 meeting, the disagreement between more or less state controls are becoming increasingly clear. It remains to be seen whether there will be fireworks at this weekend’s emergency summit.

Recession Trades Still On

As long as US economic data continues to head towards multi-decade lows and concerns about earnings plague the financial markets, recession trades are still on. My favorite are short USD/JPY and short EUR/JPY.

Earnings forecasts have been cut for the 3 Gs - Google, Goldman Sachs and General Motors. With some analysts issuing a price forecast of zero for GM, the US economy and the financial markets are in for more trouble. Coming back to haunt us is AIG - the US government has been forced to hike its bailout of the insurance giant from the $85 billion in September to $150 billion. I wonder who else will be asking the US government for more money.

This article has been reposted from Kathy Lien. The full post can also be viewed on KathyLien.com.