U.S. Dollar Unusual Behaviour Despite Continuing Risk Taking Environment

By: Money_and_Markets

Bryan Rich writes: Last week the U.S. reported better-than-expected employment data. And the markets liked it. Stocks rallied. Yields advanced. And the dollar actually moved higher.

A move higher in the dollar on good U.S. economic data might make perfect sense in most environments. But in this crisis environment, it’s unusual …

From the middle of 2008 until February 2009, the dollar had been the safe haven vehicle. But in March, when risk appetite came back into the market, the safe haven trade began to slowly unwind. That means, since March, good news for the economy has meant bad news for the dollar.

You can see it in the chart below of the British pound vs. the U.S. dollar. The pound dropped sharply (U.S. dollar rose) on risk aversion as investors fled to the dollar. Now the pound is riding higher on a wave of surging risk appetite.

Source: Bloomberg

Within this risk environment, the relationship between financial markets and risk has been abundantly clear: When risk appetite is high … stocks, commodities, interest rates and all currencies (except for the U.S. dollar) rally. When fear creeps back in, the dollar benefits, the U.S. Treasury market benefits and almost everything else goes south.

So, when last week’s employment report showed a lower unemployment rate and fewer jobs lost, the dollar should have taken a hit. But it didn’t. Instead, it rallied!

Well, one day doesn’t make a trend.

And after the markets digested a cautiously positive statement by the Fed this week on the economy, the resulting activity in the currencies spoke clearly: For the moment, it’s still all about risk appetite.

I do, however, expect a shift in market focus to take place in the near term, to accommodate this growing sentiment of recovery. I think that global capital will begin shifting toward those economies that are relative outperformers. And for 2009 and 2010, consensus estimates have the U.S. outperforming other major developed market economies.

What a Difference a Month Makes …

Last month, the IMF downgraded its forecast on the Eurozone, expecting the region’s economy to fall 4.8 percent in 2009. And for 2010, while all other economies are expected to grow, the Eurozone is expected to fall more.

Then Germany and France, the two largest economies in the Eurozone, shocked the market this week by posting actual growth for the second quarter!

The ECB recently upgraded its forecast for 2009 and 2010.

On top of that, central banks are now upgrading economic forecasts for 2009, a year that was first thought to be a complete disaster. And the 2010 numbers are being boosted even more.

In fact, the European Central Bank has now revised its expectations for 2009 and 2010: Expecting just a slight contraction in 2009 and growth in 2010.

But in a period where less bad is the new good, and economies have stopped free-falling and are now showing signs of improvement, the recovery story is about sustainability, not just data points.

Beware of Statistical Recoveries …

Let’s take a look at Germany, the world’s fourth-largest country and the world’s largest exporter. The second-quarter GDP number shows that the economy is out of recession. But other numbers tell a story that doesn’t look so convincing …

• Unemployment continues to rise,
• The work week has been shortened,
• Consumer prices have fallen for the first time in 22 years,
• Producer prices have declined at a rate not seen in 40 years,
• And retail sales continue to fall.

Source: Bloomberg

Germany’s all-important exports jumped in June, yet they were still down over 22 percent from the same period a year ago. And global demand, although ticking up in recent months, is now falling fast again. In just 10 days, the Baltic Dry Index, a good proxy for global demand, has tumbled 25 percent.

So is this recovery sustainable? Will 2011 be a return to normalcy or will recession return?

The IMF has published a study on similar recessions, those highly synchronized across global economies with the added element of financial crisis. The study concluded that they tend to be deeper and take a slower path to recovery than other recessions. These comparisons suggest that the global economy will bounce around the bottom for another two years or more.

In this risk-centric investment climate, what’s bad for the global economy has been good for the dollar, and there’s no reason to think that will change.

With that, I think the U.S. dollar will again regain its appeal. Meanwhile, as markets focus more and more on the near-term growth prospects for global economies, the dollar should begin to gain favor on a relative growth basis. It’s potentially a win-win scenario setting up for the dollar.

Regards,

Bryan

P.S. I’m now on Twitter. Please follow me at http://www.twitter.com/realbryanrich for frequent updates, personal insights and observations from my travels around the world.

If you don’t have a Twitter account, sign up today at http://www.twitter.com/signup and then click on the ‘Follow’ button from http://www.twitter.com/realbryanrich to receive updates on either your cell phone or Twitter page.

This investment news is brought to you by Money and Markets . Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com .

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.