Where Have All the Spenders Gone?

By: Brewer Futures Group | Wed, Apr 15, 2009
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The U.S. Dollar regained its status as the world's reserve currency on Tuesday as risk averse traders bought the Dollar in defense of the falling stock market. The rally in the Dollar was triggered by lower than expected U.S. economic reports which dampened the recent optimism created by speculation of a recovery in the global economy.

On Tuesday a pair of government reports showed that U.S. Retail Sales and the U.S. Producer Price Index reports surprising decreased in March. The retail report decline was totally unexpected following two consecutive months of increases. Pre-report estimates were for an increase of 0.3% but the actual report showed a decline of 1.1%. This report demonstrated the power of consumer spending or the lack therefore of.

News of the bearish report hit the stock market hard early and the downtrend continued throughout the day. With each break in the stock market, trader appetite for risk diminished for higher yielding currencies.

Once the bearish tone was established in higher yielding currencies, market participants began to question the strength of the U.S. economy, corporate earnings and the soundness of the U.S. financial system. These three factors can lead to a shift in trader sentiment which could trigger the start of a strong rally over the short-run for the Dollar.

If anything, the retail report shows that the economy may be way off from establishing a bottom. This report which is consumer driven could be a sign that consumers are entrenched with their plans to save more money than they spend. This news doesn't bode well for the U.S. economy which is driven by consumer consumption. Furthermore, it isn't a good sign for consumer discretionary stocks. If these stocks show worse than expected earnings then the stock market could continue to decline. This would lead to a shift out of equities and into the safe-haven Dollar.

The lack of follow-through in the banking sector following the strong earnings report by Goldman Sachs could also be an indication that the banking sector is not as strong as perceived. Equity traders seem to be willing to take some of their money off the table ahead of this week's reports from Citigroup and JP Morgan.

The hit to investor sentiment on Tuesday could turn into a trend if U.S. economic reports continue to come in on the bearside of expectations. In addition, the end of the stock market rally would mean that investors will have to find a safe home for excess funds. This could mean another pop in the Dollar as trader appetite for risk would wane while risk aversion increases.

The Euro fell on Tuesday as traders returned to the safety of the U.S. Dollar. The recent rally was weak anyway as traders were driven to the Euro because of demand for higher risk assets rather than the Euro Zone economy. At this time the EZ economy remains weak with production falling while consumer and business sentiment declines. Unemployment is expected to continue to increase also.

Tomorrow Germany's Federal Statistics Office will release its report on March wholesale prices. Expectations are for this report to show a decline of 7.1% compared to a year ago. Last month this report showed a decrease of 5.7%.

This report will be watched closely by the European Central Bank. They are becoming concerned about the lack of growth in the economy. If inflation continues to remain under 2% for a sustained period of time then additional easing measures will have to be implemented. This may include a substantial rate cut to less than 1% and a round of non-standard easing techniques such as a buyback of corporate bonds.

The GBP USD was the lone major currency to hold up well versus the U.S. Dollar on Tuesday although this currency did weaken late in the day. I don't expect the British Pound to rise too much further if the basis for the buying is optimism rather than real improvement in the economy.

Tuesday's strength was attributed to investor confidence in the recent moves by the Bank of England. Traders seem to be excited by the BoE's quantitative easing plans which have somewhat succeeded in restoring investor confidence to the U.K. financial system.

The recent rally in equities helped the BoE in its plans to restore stability to the U.K. economy. When stocks went up, Gilt holders lowered their offers because of their need for liquidity. This was a change from March when the Gilt market demanded higher rates leading to a failed auction.

The strength in Goldman Sachs stocks also helped the British Pound as investors now think that stability in the financial system will lead to better earnings for U.K. banks HSBC and Barclays. Traders expect to see more demand for higher risk assets if U.K. banks can show strength.

The real test for the GBP USD will be following the release of the next round of U.K. economic numbers. Right now optimism is driving this market higher but reality could hit this currency like it hit the U.S. stock market on Tuesday if the economy doesn't start showing signs of improvement.

The rally in the Japanese Yen could be signs of a short-squeeze. Traders bought the USD JPY as the stock market rallied, breathing new life into the carry trade. If the stock market stops rallying, then this money will have to come back to Japan as investors will be encouraged to pay back loans made in Yen.

The action in the Yen is all carry trade at this time as there is no economic reason to buy this currency. The economy is showing no signs of recovery as exports remain down. Exports will remain down as long as the U.S. and European economies are trying to recover. Demand from China will also have to increase in order to save the economy from deflation.

A rising Yen is not what the Bank of Japan wants to see so gains will most likely be limited out of fear of action by the BoJ. Quantitative easing and intervention will be the weapons of choice if the Yen rises too much, too soon.

The Canadian Dollar could start to feel renewed pressure if the U.S. Dollar starts to strengthen. A stronger Dollar usually means lower commodity prices. The Canadian economy relies heavily on commodity sales. Demand for industrial metals such as copper and platinum have been supporting the Canadian Dollar over the short-run. Most of this demand has come from expectations of a global economic recovery. If this optimism dries up then demand should fall.

A falling stock market could have a bearish influence on riskier currencies like the Canadian Dollar. If investor optimism wanes then traders will once again seek the safety of the U.S. Dollar.

Another factor that could contribute to weakness in the Canadian Dollar will be central bank activity. Many traders are expecting the Bank of Canada to cut rates for the last time this year and announce plans for quantitative easing. Both of these ideas would be bearish for the Canadian Dollar.

The return of the Dollar as a safe haven asset helped the USD CHF recover following a substantial loss on Monday. News that Goldman Sachs posted huge earnings helped lead a surge to the upside earlier in the week. The Swiss Franc rallied on the thought that these gains would somehow spillover to Swiss Banks.

The lack of follow-through to the upside following the gains in Goldman Sachs was disappointing to traders on Tuesday. If the weakness continues in U.S. banking stocks tomorrow then look for the USD CHF to continue to post gains.

Traders should note that the recent changes in the leadership at the Swiss National Bank did not alter any of its plans to reduce the value of the Swiss Franc. The SNB is still on a mission to force the decline of the Swiss Franc through intervention and quantitative easing until exports recover.

Weakness in the U.S. stock market encouraged profit-taking in the Australian Dollar. Carry trade investors have been supporting the recent rise in the AUD USD. News that U.S. Retail Sales were lower than estimated put a dent in investor confidence which led to selling in the equity markets.

If this is a sign that the U.S. economy is still bottoming then traders will become more risk averse which could put additional pressure on the Aussie.

Traders will be watching China to see if there is any increase in stimulus funds. Speculators are betting than an increase in funds will lead to higher Australian exports to China.

Much of the recent rally in the NZD USD can be attributed to an increase in the carry trade. Many investors have returned to borrowing lower yielding currencies and investing in higher yielding currencies like the New Zealand Dollar. If the U.S. stock market is topping then the NZD USD is likely to drop as trader appetite for risk will decrease. The market declined on Tuesday as traders fear this situation transpiring.

The Reserve Bank of New Zealand will be watching to see if China will be spending new stimulus money in New Zealand. An injection of new funds will surely help exports increase and could provide a much needed spark to the economy.

The economy aside, traders will be more concerned about demand for higher risk currencies over the short-term. If fear engulfs the market because of the U.S. economy, corporate earnings or the U.S. banking system then the NZD USD could break substantially from current levels.



Brewer Futures Group

Author: Brewer Futures Group


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