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Brown Brothers Presents Its Case For A Stronger USD Ahead Of The FOMC Meeting
BBH's Marc Chandler picks up where John Taylor leaves off and makes his case for a stronger dollar. Nothing new here, but the report appears to be having an impact on the market. In broad terms, Chandler is positive on a hawkish Fed which would bring back some strength to the dollar, while he observes nothing but total chaos in Europe: "European officials finish the year very much as they began it: finding it exceeding difficult to navigate the treacherous channel. Ironically, Obama and the Republicans have found a patch of common ground before Europe reconciled the conflicting demands. While there is a common understanding that there is no alternative to monetary union, there appears to be no meeting of the minds on how to ensure this. And there’s the rub." As he puts is so poetically, "Europe, Your Rope."
From Brown Brothers' Marc Chandler
FOMC Preview and Dollar Outlook
A new factor has arisen that complicates the Federal Reserve’s task as it prepares for its last meeting of the year. The broad outlines of the agreement between President Obama and the Republican leadership on fiscal policy is significant, even if the compromise is tweaked a bit now or passes retroactively early in the new year. Indeed, a new fiscal stimulus package will be agreed upon under the guise of tax cuts (although most are reluctant to call it that). In fact, one of the biggest surprises is the 2% payroll savings tax cut that replaces the “Make Work Pay” cut. The “Make Work Pay” cut was, after all, the largest single item in the 2009 stimulus package. As a result, economists are revising up their 2011 GDP forecasts by 0.5%-1.0%.
The Fed’s resumption of its Treasury purchases was in large part aimed to improve financial conditions, which are seen as a harbinger for stronger growth prospects down the road. An improvement in financial conditions, as the theory goes, would lead to stronger output, which in turn would reduce unemployment and mitigate the risks of the deleveraging cycle from turning into persistent deflation. Arguably, though, the resumption of large scale assets purchases appeared to be predicated on the belief that there were no more bullets in the fiscal gun.
In spite of these policy actions, US yields have risen dramatically since the announcement of QEII. Partly the market had been caught wrong-footed. Some thought, for instance, in his “60-Minutes” interview Bernanke signaled that the Fed would extend the asset purchase plan beyond the $600bln initially suggested. In our view, he did no such thing. His interview was reportedly taped on November 30 and did not unveil a new policy initiative. At the same time, the Federal Reserve Chairman was simply trying to defend the Fed’s current actions, going over the heads of his critics, and directly to the public to explain the controversial policy.
The FOMC statement clearly indicated the fuzzy nature of such policy action: It would be under constant review and that the purchases would be adjusted as the Fed saw fit based on the outlook for the economy, inflation, unemployment and the overall efficacy of the program. Meanwhile, long US Treasury positions were compelled to liquidate and the market had to discount the risks associated with the Obama-Republican compromise. Put differently, there are supply risks along with inflation risks. In addition, there are reputational risks in the sense that the credibility of US policy makers and the independence of the central bank were being called into question.
Initial estimates of the impact on the deficit may be somewhat elevated if the tax cuts do boost the economy to achieve what some economists have dubbed “escape velocity”, which is to achieve the above trend growth. That in turn is necessary to bring the unemployment rate down and stoke a broad-based economic recovery. Stronger growth means higher government revenues and low counter-cyclical spending costs, thus improving the government’s overall fiscal balance. On balance, these considerations should be taken into account when trying to assess the fiscal costs of the compromise.
FOMC Statement
How will the FOMC respond to the sharp backing up of US interest rates that has occurred? Some have suggested that Fed will announce an increase in the $600bln purchases program to protest to the higher rates. The risk of this is small. And ironically for the same reason that the majority of European finance officials do not support increasing the European Financial Stability Fund (EFSF) beyond initial guarantees. Officials in both countries are loath to act unless they have to and both the Federal Reserve’s program and the EFSF have barely begun. But the Fed may assert its commitment to assets purchases, which may in turn cap further losses in Treasuries for the time being.
Equally important, there is nothing at this juncture for the Fed to gain by announcing a longer-term program and there is much for it to lose. On the one hand, increasing it could be more destabilizing because it would be seen as a commitment. Still, this would limit the Fed’s existing options. On the other hand, the unexpected fiscal stimulus may strengthen the hand of the fifth column -- those Fed officials that oppose QEII. Unemployment is best addressed via fiscal policy and stronger growth reduces the risk of deflation. In other words, fiscal policy can take some of the pressure off extraordinary monetary policy.
In previous commentary we have expressed concern about how the Federal Reserve would exit from its program of long-term asset purchases as there may only be slow progress toward reaching its dual mandate: price stability and growth. This risk may be mitigated by another consideration: efficacy. In light of the new trajectory of fiscal policy, perhaps the ability of Federal Reserve to influence long-term interest rates through the use of its balance sheet has been compromised. At the same time, arguably there is, at least on the margins, a reduced need for extraordinary monetary policy as the economy begins to recover from the slowdown in deleveraging and resumption of consumer-driven growth.
New Dollar Driver, Same Direction
The rise in US interest rates and inflation expectations, of course, alter monetary conditions. The trajectory of such a policy mix, perhaps slightly more expansionary on the fiscal side, yet more restrictive on the monetary side, are generally associated with a rising currency.
Rising US interest rates, therefore, change the incentive structure of using the dollar as a financing currency and could shift the focus to other funding currencies such as the yen or Swiss franc. In addition, the attractiveness of emerging markets and commodities may have also been in part a function of the extremely low US interest rates. Nevertheless, this may be offset to a large degree by the improved global growth implications. Going forward, the positive impulses of this new fiscal policy, coupled with the potential for a higher interest environment, complement the existing trend of dollar strength. Overall, that trend has been driven by two main forces in recent weeks.
The first is the taking of profits on large short dollar positions established in September and October as investors discounted another bout of asset purchases by the Federal Reserve. The “sell the rumor, buy the fact” activity associated with Fed easing, including other unorthodox measures previously since the crisis began, was a catalyst for dollar weakness. Secondly, the US economic data, as it was coming out in real time, were showing a clear improvement in the economy after the soft Q2. Leaving aside the disappointing November non-farm payroll report, nearly all the other economic data have surprised on the upside.
Besides, the economy appears to be expanding faster than it did in Q3 and what appears to be the slowing of inventory accumulation does not seem to have as much of an impact on current production as expected. It lends credence to our previous suggestion that the surge in imports around mid-year (which may have been a function of the end of a Chinese export tariff rebate scheme) may have gone into inventory restocking rather than to meet current demand.
Europe, Your Rope
The second force that has helped strengthen the dollar is the intensification of the financial crisis in Europe. The smoldering fire burst into flames anew by the oxygen provided by German Chancellor Merkel’s common sense suggestion that the private sector should be involved (that means take a haircut) in the resolution of debt problems. But it was precisely that belief that bondholders were special; so special, in fact, that of all the stakeholders they would be only ones spared from participating in the collective punishment for the poor decisions made mostly by the economic and political elite that has kept the teetering confidence game afloat in recent months.
European officials finish the year very much as they began it: finding it exceeding difficult to navigate the treacherous channel. Ironically, Obama and the Republicans have found a patch of common ground before Europe reconciled the conflicting demands. While there is a common understanding that there is no alternative to monetary union, there appears to be no meeting of the minds on how to ensure this. And there’s the rub.
While the data are not very transparent, there will be a huge amount of European bonds that need to be sold next year. According to figures from Datalogic, euro-zone banks have around €600bln of debt coming due next year. Euro-zone bank issuance has been negative since May, and in the first ten months of 2010 is down 10% from the year ago period. In addition, sovereign debt issuance is estimated around €700bln. There seems to be some concentration of sovereign maturities in the first few months of 2011 and underscore euro’s downside risks in the first part of 2011.
Marc Chandler
Global Head of Currency Strategy
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Gulp ...... But , but, but .....
BIDU, PCLN falling apart. Risk off. Apparent the indexes are being help up with duct tape and bailing wire.
I've heard that Gorilla tape is pretty good, pricey though at $8 a roll but Im sure Bernank can afford it.
Actually they were being held together by clear skies in the bond market. A few rumbles out of Bondzilla, and it's time for a crash.
well, I just did the calculation: TLT is off 13% since Oct 6. would you speculate as to when we start hearing the rumbling?
Stronger dollar contrary to the Bernank's madcap plan.
Meanwhile Ben says to his printing press operator, in Captain Kirk's voice: "I need more power."
To which the operator responds: "But captain, I'm giving her all she's got.."
So will raising interest rates make DC spend less, or merely make of financial insolvency more prominent.
Funny, we will get a boost not because the dollar is strong but because the Euro sucks more.
Comparing the Euro and the dollar is akin to smelling 2 piles of dog crap to see which one smells the "best".
Strong dollar yet weekly POMO is... Oh hell, does anything FACTUAL matter now that the Ministry Of Truth has taken control.
In addition, the attractiveness of emerging markets and commodities may have also been in part a function of the extremely low US interest rates.
Bingo! Carry Trade....look it up.
After all the printing, bailouts .... I was going to buy canned food, butter, guns, whiskey .... WTF? Lol' ...
There are a lot of idiots around here stuck in a Gunsmoke fantasyland.
By the way, CaddyShack is one of my all-time favorite movies.
Spalding, Get your foot off the boat!
http://www.youtube.com/watch?v=MCvgMNnM3OA
lol
Greatest speech in the history of motion pictures:
http://www.youtube.com/watch?v=VGpQej3o9eo&feature=related
5 years ago, I use to be able to buy 1000 rounds of 9 for $99. Now, I'll be lucky if I can find the same quantity for $200. I'm not sure what's so funny to you. Your precious dollars are buying less and less.
Here's a hot tip for you:
the reason your ammo costs twice as much today than five years ago (or two years ago) has little to do with dollar depreciation and more to do with ammo producers and dealers profiting from all the Gunsmoke wing nuts that have risen off their lazy boy chairs in the past two years, and have been drafting plans for silly urban warfare scenarios.
Hey, this is only area I give credit to Obama for actually stimulating the economy and creating real consumer demand.
Yeah, the increase in copper prices has nothing to do with it. I guess the demand for ammo is so great, that gun nuts have created a demand pull effect on copper prices?
No, as far as currency strength goes, we're in a "tallest midget" contest, largely because we duped the rest of the world into investing in our "prosperity". They have also suffered damage due to their own socialist programs.
just wanted to pick a place to post this near the top. not a true reply but ..
it looks like the inverse h/s on the aud/usd, which began around nov 11th, broke out last night and might have succesfully retested this morning. it looks to target 1.03
to me, the formation represents failed attempts at suppressing parity
Weimar also funded a rather popular carry trade.
But then, I guess you don't have much time to learn anything about history, what with being Ben "Limp Dick" Bernanke's fluffer and all. Must be hard work.
Ah yes, the weimar carry trade. Marks for london gold which were repatriated for practically free raw materials. Drove up the value of all the other currencies and basically fueled the roaring 20's which lead to a global deflationary depression. Housing prices began falling in about '26 and that money was poured into the US equities. Once the dam finally burst the liquidations began. Last time it was a roaring decade. This time a roaring six decades. Let's just hope the slide to oblivion continues at a controlled pace ie everyone keeps marching lockstep to bennies cadences.
What's impressive is how flight to safety has strengthed the $ in spite of Bernanke's dastardly efforts to weaken it. Proving once again that markets are stronger than central bankers.
"Obama and the Republicans have found a patch of common ground"
Like two alcoholics will argue about plenty of things, but will always agree to go to a bar, both sides decided the best course of action was to spend more money. Europe seems to be trying to balance the books, even if this results in defaults, whereas the US wants to bury the books in the garden and pretend everything is ok. Seems to me, Europe's policies will be deflationary and hence Euros will become more scarce, whereas the US seems embarked on hyperinflation or bust. Not sure why this would be good for the Dollar, but there you go.
I find Chandler is blinded by his patriotism (in fact, I suspect he works for the CIA).
That is a very fitting analogy.
Does this mean I should cancel my order of the commemorative Queen Blythe silver coins?
DX
Stronger Dollar?
http://99ercharts.blogspot.com/2010/12/dollar_9331.html
http://www.zerohedge.com/forum/99er-charts
I agree with the "stronger dollar" call, even though I don't really know much about the whole mystery magical world of FX. I arrive by other means.
For example, I spent a good part of the last few trading sessions LOLOLOLOLing while I watched the Euro ramp up in what seemed like a really unlikely rally of quite good proportion. When I could wipe the tears of laughter away long enough to look back at the chart, it seemed clear to me to be a typical arbitrage move by the criminal syndicate known as Wall Street, whereby first they mark up in a crazy fashion...that which they intend to destroy.
As well, I have been figuring on oil NOT BEING the bff of the S&P anymore, and knowing how the syndicate works, marking things in the opposite direction of things like supply or demand, especially marking oil up while they short our currency into oblivion [which I would think would cause more outrage as we all need that dollar to buy food and energy...but...anyway]...
I figured that oil was actually pushing the dollar down rather than the weak dollar pushing oil up. And I say that because I have now figured out that EVERYTHING put forward by the criminal syndicate known as Wall Street is EXACTLY BACKWARDS as the syndicate arbitrages and destroys every living and dead thing on the surface of the earth...because that is what it knows how to do.
Oh, and I think the S&P, etf manipulated snap back rally in a lot of things will probably end very soon because I do not know anyone who will believe the gov't retail numbers over those that were released this morning by BBY...and there is no volume anywhere except on BBY...but what do I know?