Today's comment is by Jack Crooks, our Currency Director and Editor of Crooks on Currencies and The Money Trader.
Dear A-Letter Reader:
Lately, there has been no clear sentiment one way or the other in the currency markets, and for good reason. There is mass confusion on both economic growth and interest rate policy among the seven different countries that makeup the major currencies, including the United States, Japan, Europe, UK, Switzerland, Canada, and Australia.
I was expecting this to change last Friday when news hit the wires that U.S. Advance Gross Domestic Product report was weaker than expected. The dollar is officially under pressure across the board, but is it the beginning of a trend?
According to Bloomberg News' Friday report,
"The U.S. economy grew at a 1.6 % annual rate last quarter, which is the slowest pace in more than three years and less than economists forecast, as housing slumped and the trade deficit widened."
(This is also a huge drop from the 2.6% annual rate in the second quarter. We can blame this loss in GDP growth on the Fed raising rates 17 times in a row. Higher interest rates often have a delayed effect on the economy.)
Why Should We Care?
There were two pieces of information in this story that emboldened currency traders to sell the dollar and buy their favorite currency of choice Friday:
1) "...the slowest pace in more than three years..."
2) "...as housing slumped..."
Why are those two pieces of information important? It confirmed the expectations of many who already believed housing IS still a major drag on the economy and the phrase "worst in three years" paints a powerful picture. As I've said before, sentiment is key, reality is important... but it's second fiddle to what the market thinks. And if inflation isn't a threat, the Federal Reserve loses some firepower.
Taken in its entirety, the story suggests the Fed's next move will be to cut interest rates. And this rate cut could happen sooner rather than later. And when this happens, the dollar will lose some of its yield appeal (higher interest rates compared to other currencies) and economic growth appeal.
There are still plenty of players who believe this report doesn't reflect what's really happening in the economy now. The housing market seems to be the key bone of contention between who believe a U.S. recession is imminent and those who believe the U.S. economy is still just fine.
Hoisington Investment Management, an institutional bond manager who has an excellent forecasting record, sees the housing bust getting worse, and it is a key factor in their view the U.S. will either a) enter recession or, b) at best, experience much slower growth in 2007.
But optimism rings from a familiar voice. In a speech given last Thursday, former Fed Chairman Greenspan weighed in on the housing question, suggesting the economy is in decent shape. He says that: "Most of the negatives in housing are probably behind us. The fourth quarter should be reasonably good, certainly better than the third quarter."
So What the Heck Does This Mean for the Greenback?
The market is taking Friday's economic news as a negative for the dollar. But, until we find out who's right on housing, it's a tough call. Is this the beginning of a trend, or just another short-term reaction?
My gut says that we will see a downward correction in the dollar over the next couple of weeks. Particularly if last week's data confirms more U.S. economic weakness ahead, and if this Friday's release of the U.S. jobs report for October comes in lower than expected. If that happens, we will see other currencies soar against the greenback.
JACK CROOKS, Currency Director
on behalf of The Sovereign Society
