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HomeDollar Devaluation Is a Dangerous Game
Posted by Larry Doyle on October 8th, 2009 9:24 AM |
Can we ‘devalue’ our way back to our days of economic ‘wine and roses?’
Many debt-laden countries throughout economic history have chosen to implicitly or explicitly pursue a devaluation of their currency as a means of improving their economies. Are the ‘wizards in Washington’ taking this approach? Aside from a few perfunctory comments in defense of the greenback, Washington has been largely silent on the topic of the declining value of the dollar. Many believe Washington very much favors a weaker currency as a means of supporting our economy. I believe this of Washington, as well. Let’s navigate.
Going back to the G20 in London last Spring, the Obama administration has attempted to curry political favor with emerging economies, especially the BRIC nations, by ceding dollar sovereigncy as the preeminent international reserve currency in return for support of global economic stimulus programs. Why does Washington believe a weak currency serves our economic interests? A weak currency generates and supports the following:
1. Promotes inflation as imports decline. Washington would like some inflation, given the massive deflationary pressures presented by falling wages and declines in the value of commercial and residential real estate.
2. Promotes exports for corporations with a multi-national presence.
3. Supports labor by making it more attractive for companies to keep jobs here as opposed to opening factories or sending work overseas.
So, in light of our current economic crisis, why wouldn’t we want a substantially cheaper dollar to maximize these benefits?
Recall that economists always need to keep certain variables static in order to study the impact of a change in another variable or multiple variables. This approach, known as ‘ceteris paribus,’ is not quite as easy as some may think. Why? Variables are NEVER static, or ‘ceteris is NEVER paribus.’ (more…)
U.S. Markets Play “Follow the Leader”
Posted by Larry Doyle on October 7th, 2009 9:40 AM |
Yesterday’s rise in rates by the Australian central bank is a bellweather sign of the global shift in the balance of economic power. While the rise in rates by the Aussies is the first central bank move, it certainly will not be the last. Why did the Aussies raise rates and what does it mean both in the short term and for the long haul? Let’s navigate.
The Australian economy did not have near the level of debt that burdens the U.S. and Europe and thus they did not need near the amount of monetary stimulus to weather this global recession. Additionally, Australia has benefited from extensive trade in the Asian hemisphere.
The knee jerk reaction in the markets was focused primarily on a selloff in the greenback which supported a move higher in commodities and global equities via the ‘positive carry trade.’ The commodity which garnered the greatest focus was gold, which moved toward $1040/ounce.
What do these moves mean? I see cross currents on the economic landscape, including:
1. The dollar may not necessarily continue to weaken, but given its current weakness it will support those companies which garner a greater degree of sales overseas.
2. A weak dollar is usually affiliated with inflation. I do not think we are in a position to look at prices in terms of one overall index. Why? Given the technical and fundamental factors in our economy, certain price components will likely project increased inflation while others will not.
To be more specific, given the labor situation in our country, I do not see any appreciable increase in wages anytime soon. In fact, I think it is likely wages will trend lower.
Given the glut of supply and vacancies in both the residential and commercial real estate markets, I have a tough time believing these prices will move appreciably higher anytime soon.
Commodities may very well move higher. Why? High five to MC for sharing with me that there is increased dialogue in the international trade community to move oil away from trading in dollars. In fact, that story likely had a big impact in yesterday’s trading. Even if there is not an immediate shift in this market dynamic, the mere fact that it is being discussed will support oil specifically, oil-based products broadly, and other commodities as well.
Given that these commodities are primarily inputs, the prices for the outputs will likely move higher. This development is clearly inflationary.
3. What happens to interest rates here in the United States? While on one hand we have some deflationary forces at work which would keep rates low, we have the tug of other factors pushing them higher. How does it play out? My gut instinct tells me that overall pools of capital will be flowing away from the United States and, as such, people and private corporations will have to pay more to attract capital here in our country. I think those entities which focus the bulk of their economic activity here in the United States will be forced to pay higher rates to attract funding.
4. What about our equity markets and the Fed? While the Fed will want to keep our rates low for an ‘extended period,’ they may not have that luxury. If other nations follow Australia in raising rates, the U.S. may need to withdraw some liquidity sooner rather than later. Kansas City Fed chair Thomas Hoenig made this very assertion yesterday.
What would higher rates mean or even the thought of higher rates mean? Slower growth and a tough road for equities going forward.
Thoughts, comments, questions always appreciated.
LD
Related Sense on Cents Commentary
Dollar Carry Trade Drives Global Equities (September 16, 2009)
What Does the Fed’s Statement Mean for Mortgage Rates?
Posted by Larry Doyle on September 23rd, 2009 3:40 PM |
The Fed’s statement at 2:15pm had no real surprises, but there is one development that bears comment — especially for anybody looking to finance or refinance a home. The Fed stated:
To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009.
What does this mean? The Fed’s program of buying mortgage-backed securities to support housing was scheduled to end December 31st. It will now be extended through the end of the first quarter 2010. The fact is, though, the Fed is not purchasing more MBS (mortgage-backed securities) than the previously advertised $1.25 trillion. The Fed is merely lengthening the time over which it buys those MBS.
Add it up, and the largest buyer of MBS in the market will have a lessened impact because its purchasing power is being diluted via this extension. As a result, overall conforming mortgage rates will not likely come down much if Treasury rates were to continue to decline. By the same token, if Treasury rates were to rise, mortgage rates will likely rise at an even faster rate.
Recall that just the other day Wells Fargo CEO John Stumpf shared that his bank was not purchasing any MBS for its own portfolio nor was it retaining any of its own mortgage originations. Why? From a pure relative value standpoint, MBS are overvalued. Why? The Fed has effectively been overpaying to buy MBS in an attempt to get mortgage rates down and support housing.
With the end of the Fed’s purchase program on the horizon, mortgage rates will likely start to move higher in order to attract other potential investors.
What is a homeowner to do? Don’t wait to refinance thinking that rates are going to come down much further.
LD
Is the Wall St. Block Party at the Geithners and Bernankes Breaking Up?
Posted by Larry Doyle on September 23rd, 2009 12:37 PM |
Are Big Ben Bernanke and Turbo-Tim Geithner preparing to gently turn the lights up, turn the music down, put away the hard booze, and throw the coffee on? Have the partygoers on Wall Street had too much of a good time? Has the ‘liquid-ity’ flowed a little too liberally at this bash?
We will all learn more today at 2:15pm or thereabouts when the Fed releases its regular statement assessing our economy. Will a slightly more positve view of the economy actually be met with a selloff in the markets? I believe that may very well happen. Why? The Wall Street party’s ‘hosts,’ that being Bernanke and Geithner, need to prepare the partygoers to sober up, which is a very delicate undertaking. As with any sobering process, the first thing you do is make sure you have called your friends down at ‘the station’ so nobody gets picked up unnecessarily. That ‘cover’ has worked wonders for a long time, but the partygoers may want one more ‘get out of jail free’ card at this juncture. We saw as much in the token fine assessed by the SEC ‘cops’ against Bank of America just last week.
Bloomberg highlights the predicament of the party’s host in writing, Fed May Signal U.S. Economic Recovery Has Started. We do not need to be mentalists to read the tea leaves indicating the Fed’s juice is likely to slow and that it may be time to go home. Bloomberg writes:
>>”The bottom is no longer falling out, but the recovery is still at a very early stage,” said Gertler, who worked with research on the Great Depression with Bernanke before he became Fed chairman. “There is no need to expand the balance sheet now, but it is a bit too early to begin shrinking it.”
>>Central bank officials may also discuss changing the size and duration of their plan to buy as much as $1.25 trillion of mortgage-backed securities and $200 billion of agency debt by the end of this year, said former Fed governor Laurence Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers LLC.
>>Three district bank presidents — Jeffrey Lacker of Richmond, James Bullard of St. Louis and Dennis Lockhart of Atlanta — raised the possibility that the Fed may not spend all the money authorized for the mortgage-backed debt.
>>Fed officials have started talks with bond dealers to use so-called reverse repurchase agreements to drain some of the cash the central bank has pumped into the economy, according to people with knowledge of the discussions.
How are the partygoers on Wall Street preparing for the slowing, if not the end, of this block party? The Treasury yield curve is flattening today. I highlighted this likelihood yesterday when I wrote, “Is the Federal Reserve Readying a Stealth Tightening of Monetary Policy?”
You do not have to listen very hard, though, to hear the crowd on Wall Street sharing their feelings. In fact, this classic tune by Southside Johnny and the Asbury Jukes is playing on Wall Street right about now. ~ LD
Related Sense on Cents Commentary:
“Bernanke Promises to Keep ‘Punch Bowl’ Filled” (July 21, 2009)
Is the Federal Reserve Readying a Stealth Tightening of Monetary Policy?
Posted by Larry Doyle on September 22nd, 2009 4:11 PM |
The Federal Reserve impacts the economy by raising and lowering the Federal Funds Rate. With the Fed Funds rate currently at a range of 0-.25%, the Federal Reserve has no more ammo to positively impact the economy, right? No! Readers of Sense on Cents are fully aware of the other measures the Fed, in conjunction with the Treasury, has utilized to inject money into the economy, including:
1. quantitative easing in which the Fed has purchased U.S. Treasury and mortgage-backed bonds
2. backstopped money market funds (FYI . . this program ended last Friday)
3. providing federal guarantees for banks to issue debt
4. facilities to assist in the issuance of securitized assets (TALF)
Collectively, these programs have achieved an effective negative Fed Funds Rate. This development is not only historic but very daunting for the economy and market. When and how will the Federal Reserve and Treasury begin to exit some of these programs, and take some liquidity out of the system without spooking the markets? In the process, the Federal Reserve will begin a de facto tightening of the monetary policy even if it does not immediately begin to raise the Fed Funds Rate.
This tightening process may be in its formative stages. How do we know? Bloomberg reports, Fed Said to Start Talks With Dealers on Using Reverse Repos:
The Federal Reserve has started talks with bond dealers about withdrawing the unprecedented amount of cash injected into the financial system the last two years, according to people with knowledge of the discussions.
Central bank officials are discussing plans to use so- called reverse repurchase agreements to drain some of the $1 trillion they pumped into the economy, said the people, who declined to be identified because the talks are private. That’s where the Fed sells securities to its 18 primary dealers for a specific period, temporarily decreasing the amount of money available in the banking system.
Given the amount of liquidity the Fed has pumped into the economy over the last year, these reverse repurchase agreements would have to be of huge size and for a longer tenor in order to truly make an impact.
What would be the impact of sizable reverse repurchase agreements? I would make the following assessments based upon my feeling that the market would perceive these agreements as a tightening of Fed policy:
1. the yield curve would flatten, meaning short term rates would raise relative to long term rates (revisit your Algebra II chapter on slope)
2. the U.S. dollar would strengthen as the market perceives this move an indication that the Fed is closer to raising the actual Fed Funds Rate than it was previously.
3. the markets, both equities and bonds, would very likely sell off in a reversal of the price action of the last six months. Both our equity and bond markets have been supported by the cheap funding provided by the Fed. This phenomena led to the dollar carry trade which I highlighted a week ago in writing, “Dollar Carry Trade Drives Global Equity Markets.”
The dollar is getting hammered again today and that fact is supporting our markets, both equity and bonds. Watch the US Dollar Index as it is clearly the best indicator as to the Fed’s intentions and market direction. If and when you see the dollar start to improve (currently quoted at 76.13), then look for stocks and bonds to weaken.
LD
Federal Reserve Fighting Transparency
Posted by Larry Doyle on August 27th, 2009 12:54 PM |
Given the enormous costs and burdens currently being borne by the American taxpayer during this financial crisis, are taxpayers supposed to blindly trust the Federal Reserve? Kudos to Bloomberg News for doggedly pursuing increased transparency on behalf of the Fed. Bloomberg reports, Federal Reserve Says Disclosing Loans Will Hurt Banks:
The Federal Reserve argued yesterday that identifying the financial institutions that benefited from its emergency loans would harm the companies and render the central bank’s planned appeal of a court ruling moot.
The Fed’s board of governors asked Manhattan Chief U.S. District Judge Loretta Preska to delay enforcement of her Aug. 24 decision that the identities of borrowers in 11 lending programs must be made public by Aug. 31. The central bank wants Preska to stay her order until the U.S. Court of Appeals in New York can hear the case.
“The immediate release of these documents will destroy the board’s claims of exemption and right of appellate review,” the motion said. “The institutions whose names and information would be disclosed will also suffer irreparable harm.”
The Fed’s “ability to effectively manage the current, and any future, financial crisis” would be impaired, according to the motion. It said “significant harms” could befall the U.S. economy as well.
The central bank didn’t say when it would file its appeal.
Fed lawyer Kit Wheatley told Preska in a conference call today that she did not know how long it would take for the Fed board to search the New York Fed for records.
“We really don’t know what’s in New York,” Wheatley said. “We don’t control the system of record-keeping in New York.”
The Standard
The Fed’s lawyer went on to say that she did not know what records would fall under a “delegated function,” which would be a task assigned to the New York Fed.
Preska interrupted Wheatley, saying that “Ms. Wheatley, I held that’s not the standard. You didn’t search under the regulation. You’re supposed to search under the regulation.”
Preska scheduled another conference call for 2:30 p.m. today to discuss the schedule for a search of the New York Fed.
“Nobody is going to deny you your right to an appeal,” Preska said on the call, “We’re going to do it expeditiously, not in a piecemeal fashion and hand it all off to the Second Circuit.”
The Fed has refused to name the financial firms it lent to or disclose the amounts or the assets put up as collateral under the emergency programs, saying disclosure might set off a run by depositors and unsettle shareholders.
Bloomberg LP, the New York-based company majority-owned by Mayor Michael Bloomberg, sued on Nov. 7 under the Freedom of Information Act on behalf of its Bloomberg News unit. (more…)
Big Ben Will Leave His Credit Card So Wall Street Party Can Rock On
Posted by Larry Doyle on August 12th, 2009 11:10 AM |
It’s getting late but the party is going strong. The chaperone is growing weary and knows it is time for a graceful exit. The partygoers, however, are having so much fun; their youthful exuberance and enthusiasm is peaking after a difficult stretch. What is the next dance that will break out?
Welcome to the world of Wall Street and Washington, August 12, 2009. Today all eyes are on Ben Bernanke as the Federal Reserve wraps up their two-day meeting, with a Fed release at 2:15pm.
How will Ben thread the needle in the process of keeping the inflation hawks at bay while not spoiling the current Wall Street bash? ‘Fed-speak’ is carefully scripted and typically all encompassing. In so many words, Bernanke will highlight the progress made to date, while simultaneously invoking the need for continued support given underlying economic concerns.
From a practical standpoint, there is little doubt Bernanke will again reiterate his message of leaving the Fed Fund rates at 0-.25% for ‘an extended period.’ He will likely try to spin the expected end of the Fed’s quantitative easing program as purely a function of the ongoing economic recovery.
The concern, though, remains that Ben will let the party get overly rambunctious. Don’t think for a second that the Wall Street crowd is not already feeling ‘mighty good’ and ‘well lubricated’ looking forward to a quick return to those outsized bonuses thanks to Ben’s easy money policy.
In short, figuratively Ben will look to leave the festivities but will leave his credit card so the boys can rock on.
Where are the cops?
LD
Related Commentary:
Bernanke Promises to Keep ‘Punch Bowl’ Filled (July 21, 2009)
Fed May Recognize Faster Growth, Keep Rates ‘Exceptionally Low’
by Steve Matthews and Vivien Lou Chen
Bloomberg; August 12, 2009
Don’t Fight the Fed
Posted by Larry Doyle on July 30th, 2009 12:37 PM |
“Cover all your Treasury shorts!!”
I will never forget that mandate put forth by Tom Kirch, then head of Fixed Income at First Boston, as the stock market was crashing in October 1987. As a young trader, moments like that are not soon forgotten. Why? Mr. Kirch through dint of experience knew that you “don’t fight the Fed.”
With the crash of the stock market, the Fed cut interest rates and flooded the system with liquidity. In the process, the U.S. Treasury market had a massive rally. Kirch knew what was going to happen and saved the firm millions in the process. You can rest assured I immediately broke out some ‘Buy’ tickets and covered my Treasury shorts in a heartbeat.
“Don’t fight the Fed” is a tried and true rule of trading on Wall Street. While the bond market can often get overbought or oversold in the midst of a Fed easing or tightening scenario, ultimately if the Fed wants to move rates in one direction or another, it will make it happen.
Fast forward to the Brave New World of the Uncle Sam Economy 2009. How are market participants supposed to view the Fed currently? Dare I say, as challenging as it may be for market participants, myself included, “don’t fight the Fed” is still very much applicable. How so?
(more…)
Further Indication of a Stealth Tightening by the Federal Reserve
Posted by Larry Doyle on September 25th, 2009 1:55 PM |
I enjoyed reading the tea leaves embedded in just such a commentary, The Fed’s Job Is Only Half Over, in today’s WSJ. The writer, Kevin M. Warsh, is a senior Fed official and a member of the Federal Reserve’s Board of Governors since 2006. Mr. Warsh writes in a very professional fashion while laying out the Fed’s actions to date. His commentary gets most interesting in looking toward the future. While not negating the Fed’s policy statement released the other day, Warsh leaves little doubt as to which way the Fed is leaning:
What is Warsh saying? The Fed is going to need to withdraw liquidity from the system sooner than what economic indicators may indicate or market participants may desire.
What is Warsh saying here? The Federal Reserve can not simply flood the system with liquidity to the benefit of market participants, but without thoughtfully considering the loss of its credibility.
Why is Warsh, on behalf of the Fed, releasing this commentary? In my opinion, I believe the Fed is becoming increasingly concerned that excess liquidity has flooded the system, driven asset levels too high, and the dollar too low. In the process, if liquidity were to continue to flow, the cost could be a dangerously precipitous decline in the value of the greenback.
Add it all up, and although the Fed does not want to spook the markets, this statement is an indication that the Fed is getting ready to take its foot off the accelerator. In the process, our equity markets should give ground.
LD
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