IB FX View

Geithner’s plan

Tuesday July 14, 2009

It would be a brave man who stood in front of a hall full of wealthy Arabs and told them that the U.S. economy was headed irreversibly downhill dragging the dollar in tow, which would lead to the decimation of most of the Gulf States’ hoard of recycled petro-dollars. We’re not saying that U.S. treasury secretary isn’t a brave man, but we think he did the right thing by talking up recovery prospects earlier in Jeddah, Saudi Arabia. The dollar is a little weaker, but that’s partly due to a broadly better feeling today about a recovering economy, which in turn is reducing the demand for safer assets.

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Hot on the heels of Monday’s rally for equity prices, U.S. retail sales for June came out with a healthy 0.6% gain for June after having risen 0.5% in May. Strong earnings at Goldman Sachs and Johnson & Johnson helped confirm Mr. Geithner’s comments suggesting that the U.S.-led recovery is on track.

The dollar is marginally weaker today. The main culprits here are the Canadian and Australian dollars. The Canadian is building on yesterday’s reading of business and consumer optimism, which displayed the largest net number of optimists in a decade. This is seen as confirmation that the economy is pulling out of recession. The Canadian dollar has risen to a two-week high buying 87.54 U.S. cents. Canadian vehicle sales for June also repeated a 1% rise in May, further boosting confidence. Rising crude oil prices, which is Canada’s main export, lifted the September contract back towards $61 per barrel.

The Australian dollar had good reason to rally as it moved up sharply to 78.71 U.S. cents after a National Australia Bank survey finally turned in a net positive reading of optimists. The plus-four reading for this month follows an unhealthy stack of 17 consecutive months during which pessimists sang the chorus line.

The Japanese yen has managed to maintain a bid and has risen to 92.84 versus the dollar today. Elsewhere the British pound reacted favorably to news that after 20 months of falling home prices around the nation’s capital, London, real-estate agents reported in June that prices turned around. The RICS survey of selling agents and surveyors has provided a catalyst to sterling buyers who have driven the pound up to $1.6263 today.

Against the euro the dollar is stronger, but we’re a little surprised at how slow the dollar is to take advantage of ZEW survey data, which reports German investor and analyst expectations. The reading disappointed hopes for a reading of 47.8 and actually slipped from May’s 42.7 to read 37.5. Many have wagged their fingers at the Eurozone or the response on behalf of its governments for not dealing heartily enough with the financial crisis. After the initial global response to stimulus, it would appear that things are calming on the continent, which ought to be far more negative for the euro than would appear today. A single euro buys $1.3944 after failing to rise through $1.40 earlier.

Mr. Geithner’s bullish growth message was peppered with caveats about economic recovery. He noted that there would be setbacks along the way to recovery, which was largely a symptom of the withdrawal of an extended era of excessive borrowing. This, he said, would lead to an unusual amount of temporary setbacks in the recovery phase thanks to the wealth destruction and damage inflicted on the world’s financial system. Despite the $2 trillion collective government stimulus package aimed at arresting $1.7 trillion in banking losses, credit conditions remain tight.

An interesting aspect of Mr.Geithner’s address was that he seemed to put the dollar at the core of the monetary stability efforts. This is in contrast to those recent demands for less reliance on the dollar especially from emerging nations whose economies are rapidly ascending in importance. He said that the U.S. is committed through its policies to create monetary financial stability and as such the key is in the management of its debt and expectations on the future debt burden. Only by persuading global heads that the U.S. will change its future policy towards prudent fiscal management can it bolster the role of the dollar. In a sense Mr. Geithner announced that the administration had resolved to address the concern felt by investors who might previously have thought that a rising debt situation even before the crisis was unsustainable. Only by dealing head-on with the reality that the U.S. faces a far worse situation today, will it be able to convince the world that a stable dollar is the key to managing that debt.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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