IB FX View

Behind the garden wall

Wednesday May 27, 2009

Free markets that were once proud to show off the success of the capitalist system on which they were built have come to a crashing halt over the past two years. Greed got the better of society. It used to be that fast-expanding economies would proudly show off the beautiful flowers in their gardens, but since governments and central banks have had to step in to maintain scant evidence of growth, it would appear that walls have been built around the largest gardens to protect them from the both internal and external elements. Those walls represent the tall nature of government spending to ward off recession and couch growth. Many investors don’t mind stretching to see over the walls, while some are forced to draw up the ladder to peer over the highest – that of the United States. The problem for the U.S. is at what point the ladder becomes too tall for investor worried about what might happen should they lose their footing.


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The analogy provokes our mindset this morning thanks to the rally in the British pound to an eight-month peak against the dollar above $1.60. It’s also rallying against the euro at 86.98 pence proving that it’s not simply a case of dollar weakness underfoot. The S&P ratings warning over the possibility of a loss the country’s AAA-status appears to have left its hallmark on investor appetite for the pound for all of about two hours when it was announced last week. Instead, investors cast dispersion on the dollar and questioned what of its fate should the U.S. lose its rating. That feeling was neatly summed up by PIMCO’s Bill Gross who casually concluded that yes, America would lose its AAA-crown ‘eventually.’

It would seem that, although investors are concerned by government stimulus spending in their dealing with broken economies, there are limits. It’s worth peering over the garden wall just so long as the ladder isn’t set too high as to deter them from clambering up a few steps.

The additional rungs to the ladder keep getting added as the Fed has to tap the market for more debt. The drastic rise in the yield curve in recent days has sent a strong message to the U.S. that it’s going to have a hard time raising money going forward. Either that or the market is increasingly of the conviction that the situation is now in hand and that the economy is set to heal on its own. But while the garden wall keeps rising, currency investors grow increasingly concerned that they could fall off the ladder and suffer a nasty bout of damage.

The National Association of Business Economists now expects the U.S. to expand in the third quarter by an annualized rate of 0.7% after a second quarter contraction of 1.8%. That despite the increasing volume of joblessness, which could see around 4.5 million more jobs lost forcing the rate of unemployment to 9.8% before the end of 2009.

The increase in U.S. consumer confidence reported yesterday provided a tailwind for equity prices and simultaneously reduced demand for the Japanese yen as a safe haven. Today that theme continues with the dollar buying 95.20 although the euro has faltered to 132.33.

It’s too early to tell whether the potential loss of its country rating will permanently harm the dollar. Some investors clearly fell off their ladders late last week in shock at that prospect, while others have determined that if the U.S. wants to continue growing prize tomatoes, it will need to do so without that mantle.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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