Dollar debasing jet-stream

Softer income and spending data in the US yesterday raises questions about how healthy the important shopping season will be. Will the pending QE2 announcement provide the Midas touch? It’s been well documented that the problem with this ‘policy’ is that it does not add net assets to the private sector. This is the primary misconception regarding QE. The expansion of the monetary base is not ‘net new money in your pockets’. By day’s end, it will not help finance new spending or corporate investment, it will not create jobs and it will not increase aggregate demand. So, what’s the point? Someone is betting on a sustained psychological change. That is all the US government really has to offer at this moment as we encroach on 10% unemployment.

The US$ is weaker in the O/N trading session. Currently it is lower against 13 of the 16 most actively traded currencies in a ‘volatile’ trading range.

Forex heatmap

US data was mixed yesterday and should have little bearing on the Fed’s pending announcement tomorrow. Analysts concede that pressure on personal income also highlights the pressure on the Fed to boost the economy. US consumer spending remained soft in Sept (-0.1% vs. +0.2%) and was split between the role of higher prices and a higher volume of spending. Even adjusting for inflation the headline was a miserable +0.085, m/m. It’s noted that the US consumer remains ‘dependent upon government transfers for income growth’, and even with that there are question on how healthy the important holiday shopping season will be. Digging deeper into the spending subcategories, the real-gain was driven by higher durables spending (+0.8%), with services spending (+0.056%) playing a secondary role, and nondurables spending fell -0.18%. One of the go to inflation indicators for the Fed, the headline price deflator for total spending, came in as expected (+1.4%), while core-inflation happened to print a mildly weaker than expected flat release (+0.0% vs. +0.1%). Even more disconcerting to see was the total personal income had fallen to -0.1% (first time in eighteen-months). Wage and salary disbursements came in flat, marking the second consecutive month of decelerating growth. The other components for personal income were eclectic, proprietor’s income was up +0.5%, rental income increased by +1.2%, but personal income receipts on assets was down -0.3%. The price-adjusted personal income ex-current transfer receipts has remained unchanged for three months, pushing the personal savings rate to +5.3% from +5.6% in Aug. In reality, US personal incomes are flat-lining, forcing individuals to use their savings to finance purchases. This is not the ideal way to prop up incomes.  

Not to be left behind by China’s strong manufacturing numbers this week, the US’s manufacturing expanded at its fastest pace in five months yesterday (56.9 vs. 54.2). The details were surprisingly strong with the ISM’s new orders climbing to 58.9 from 51.1, while the production index jumped to 62.7 from 56.5. Again, it seems that US manufacturing is outstripping other facets of the US economy. The employment gauge rose to 57.7 from 56.5, and the index of export orders increased to 60.5 from 54.5. The inventory index fell to 53.9 from 55.6 in Sept., while the print of customer stockpiles rose to 44 from 42.5. Now we can make our way back to further Fed speculating.

The USD$ is lower against the EUR +0.58%, GBP +0.23%, CHF +0.64% and higher against the JPY -0.15%. The loonie received support from all the four corners of the globe yesterday. Stronger manufacturing numbers in both China and the US favor commodity prices, which usually affects growth sensitive currencies like the CAD. With US income and spending on the soft side, suggest fresh ammunition for the FOMC to vote for substantial QE2 tomorrow. Last week, the Canadian growth rate for Aug. came in as expected (+0.3%), with all the subcategories again putting in a solid performance. Canadian policy makers remain focused on the downside risks of the US economy, as the Canadian economy continues to be shackled to its largest trading partner, and the very reason why the BOC have prudently stepped to the sidelines. The loonie has been caught in ‘the dollar debasing jet-stream’. Last week Governor Carney stood down on hiking rates as expected, citing a softer outlook for the Canadian economy. Futures prices have priced in a ‘no-hike’ for the next six-months despite policy makers continuing to see the risk to the inflation outlook as being balanced. The BOC said that the ‘more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending’. They did not go all out neutral on future rate hikes, but noted that certain factors stand in the way. Canadian data highlights this week see the Oct. Ivey PMI on Thursday and the employment release on Friday. Now it’s back to the waiting game.

Both Australia and India seem to be getting ahead of the curve and have hiked rates unexpectedly O/N just as Japan and the US consider additional monetary stimulus, which could increase the risk of an influx of capital into both Asian-Pacific countries that might ‘exacerbate inflation’. The Australian rates market was not able to price in a hike after the weaker than expected CPI-inflation data for 3rd Q, and was completely flatfooted by the RBA’s decision to hike rates +25bp to 4.75%. The AUD rallied to just short of parity and 3-year rates jumped +10bp. This was the first hike since May. The following communique emphasized both the strength of the domestic economy and signs of recovery in its main trading partner, China. Specifically, the RBA pointed to a combination of higher wages, on the back of strong terms of trade gains, strong employment and improving credit growth in an economy with already limited spare capacity. Governor Stevens take is that this will keep domestic demand potent medium-term and that inflation likely to rise in coming years. Importantly, the RBA said ‘this outlook, which is largely unchanged from the Bank’s earlier forecasts, assumes some tightening in monetary policy’. Analysts now expect the strength of the commodity sector will keep spare capacity tight and the RBA to continue hiking in 2011. They are done for this year. All of this is a good enough excuse for the currency to trade aggressively at a premium vs. the dollar in the medium term (1.0000).

Crude is higher in the O/N session ($83.24 +29c). Crude prices have rallied this week as speculators increased their bets of higher prices after stronger manufacturing data in China, adding to signs that economic growth is withstanding cooling efforts by the government. The market is betting that a quantitative easing announcement will support that recovery, weaken the dollar again and support commodities. The danger is that speculators may be getting ahead of themselves. Even with supplies growing it’s the dollars direction that dominates the black-stuffs prices. Last week’s EIA report again blindsided the market to a certain extent, although the direction was not surprising the volume headline print was. The release was greater than five times analyst’s expectations. Crude climbed +5.01m barrels to +366.2m last week, the biggest increase in four-months. The market had only priced in a +1m barrel gain. Offsetting the reported surplus was the plunge in gas stocks, falling -4.39m barrels to +214.9m. Analysts were estimating an increase of +625k barrels. The net effect was a zero-sum report. Crude analysts note ‘this is currently a shoulder season for product demand ahead of the winter heating season’. Technically, we should see inventories gravitate towards their highs. The market remains wary that the underlying fundamentals have not changed. The ‘big’ dollars value continues to push prices about.

A positive move for the dollar was bound to affect the yellow metal. Year-to-date, there has been a strong correlation between the two asset classes. With the greenback rebounded yesterday eroded the appeal of the metal as an alternative investment. It’s the depth of the pull back that will test the underlying strength of the commodity. In this morning session with buck under pressure, gold shines. Last month, the commodity rose +3.7%, printing a new record high of $1,388.10 an ounce, as the dollar fell -2.2%. QE2 chatter dominates the market and there are two trains of thought, some argue that a measured move this week may have a muted affect on the dollar, while others suggest that further easing would weaken the dollar irrespective of the size as investors chase higher yielding assets in other countries. For most of this year speculators have sought an alternative investment strategy to the historical reserve currency. The market has been using the commodity as a proxy for a ‘third reservable currency’, the reason for the record highs. The debasing fears of the dollar, coupled with the sustainable growth issues of the US economy have had investors seeking protection in an asset with a ‘store of value’. It’s now up to the Fed to provide direction ($1,356 +$6.10).

The Nikkei closed at 9,159 +5. The DAX index in Europe was at 6,606 up +1; the FTSE (UK) currently is 5,713 +19. The early call for the open of key US indices is higher. The US 10-backed up 2bp yesterday (2.62%) and is little changed in the O/N session. Treasury prices got a boost in the early session yesterday after one of the Fed’s preferred inflation indicators, the core-price deflator, was unchanged at +1.2%, y/y. The FI asset class happened to pare some of these gains after the PMI expanded faster than forecasted last month, damping speculation that helicopter Ben will step up deep debt purchases to boost the economy. With the US economy showing signs of stability, the market should expect further position adjustments ahead of the Fed’s announcement tomorrow as the masses speculate on the buy back numbers.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell