IB FX View

Dollar weakens on global recovery theme

Friday May 29, 2009

The big theme to close the week and the month of May appears to be the rising tide of optimism for economies around the world. Strong production data out of Japan, growth figures from India along with rising retail sales in Germany conspired to send the dollar through $1.4100 on Friday allowing euro bulls to write that number on a trading ticket for the first time in 2009. The Japanese yen managed to rally despite recent evidence that its investors are growing increasingly confident and are investing overseas. However, following an awful Chicago-area PMI reading this morning it advanced against the dollar to 95.82 while against the euro it rallied to 134.91.


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Signs that a collective $13 trillion in government spending and stimulus is having an effect make for a good dollar-bashing story. Stronger than expected Indian GDP earlier today at 5.8% in the first quarter saw stronger demand for its rupee, and don’t forget a new and less restricted government just received an overwhelming boost from voters.

The dollar took fright overnight after a warning from an Asian agency harmed the prospects for plans to raise the issuance of U.S. government debt. South Korea’s National Pension Service dropped the cymbals earlier with its notice that it had less room in its portfolio for U.S. bonds going forward. Fear of the unknown in terms of a possible loss of its AAA-national credit rating provides ongoing reservations for nations in fear of a loss of value in the dollar, which would undermine their holdings. At the end of 2008 the national pension fund listed $187 billion in assets.

Industrial production in Japan grew at a faster than forecast clip of 5.2% and the rebound marked the largest monthly expansion in 56 years according to the Japanese Trade Ministry. While much of the Asian regional pick-up has perhaps been government inspired, especially in China, it leaves behind severe excess capacity in terms of labor and under-utilized factory space in Japan. Further, the rebound in activity might not last over the long haul when one considers that the region has become the home to manufactured exports, which ultimately end up in Western American ports. And while we know that the drop off in consumption in the U.S. has been tempered after the credit freeze begin to thaw in the first quarter, there are huge question marks overhanging the return to the kind of demand, which would keep Asian factories gainfully employed.

But for now the rebound has increased demand for physical commodities and that plays right into the hands of commodity-exporting nations. The Australian dollar is off to the races today and has traded within an ace of 80 U.S. cents for the first time since the beginning of October 2008. Australian bank lending grew only marginally in April but marked the fourth straight monetary expansion in the nation. The drop in the value of the greenback has partially inspired investors to favor physical commodities, a traditional hedge against a weaker dollar. But it’s also seen as a recovery play and with the evidence from China, India and other Asian nations it’s easy to understand. Prices of many commodities are on fire.

Copper prices are at a three-week high. Following another North Korean short-range nuclear test, the price of gold is at a three-month high and fast closing in on $1,000 per ounce once more. The price of silver used for industrial and jewelry-making had its largest single-monthly rise in 22 years throughout May. Meanwhile crude oil is blistering northwards and is likely undoing the unintended yet effective tax reduction that helped U.S. consumers whether the worst of the financial crisis earlier this year. OPEC’s decision to maintain its production quota coupled with a depletion of U.S. inventories helped lift prices.

Signs of recovery abroad, although welcomed by the Obama administration mask the hurdle it faces in dealing with the housing crisis. The administration earlier tried to persuade would-be first-time homebuyers that the combination of low mortgage rates and a tax incentive of $8,000 should be enough to help bring price declines to a halt and a return to confidence. However, the fastest rise on record in delinquencies last month and a record default rate hitched to ongoing price declines are threatening to derail the plan. In addition the rise in bond yields, as worries over the amount of debt issued grow, is taking money out of consumers pockets. The 19% decline in refinancing activity last week as told by the Mortgage Bankers Association is another sign that the bulk of mortgage applications from rate-sensitive homeowners is over.

Meanwhile, the British pound rose on the unexpected news that the Nationwide Building Society’s index of house prices grew 1.2% in May confounding expectations for a 0.9% decline. A measure of consumer confidence also clung to its least bad reading in two years and so added weight to the argument that Britain’s recovery is on track. The pound is currently trading at $1.6068 and is stronger against the euro at 87.95.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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