Five years ago the financial world was coming to an end. The stock market tanked and interest rates went negative due to the unsurpassed flight to safety in U.S. Treasuries. Most of this was due to greedy lending practices that claimed to be championing President Clinton’s thesis that everyone in America should be able to own a home. Lax lending requirements that were intended to get lower income earners into their own homes travelled up market and allowed upper middle and upper tier earners to refinance their houses at artificially low rates to buy second homes and Harley’s. Once again, misguided bureaucratic endeavors have been perverted by greed. The roaches in China are beginning to surface and the banking system stress tests in Europe are uncovering the depth of this five-year-old issue and once again, the primary beneficiary of these actions will be the U.S. Dollar.
The U.S. Dollar surged through its daily resistance and is well on its way into the overhead weekly resistance between 75.88 and 77.24. Although the rally has been impressive, it’s important to maintain the perspective that the Dollar is in a bear market. Even if we were able to rally another 300 points, that would only bring us back to the 38% retracement level from the ’06 highs.
Of recent interest in the Dollar’s surge are the factors that television commentators claim are fueling it. The major factors receiving notice are, the decline in energy prices and commodities in general, the European Central Bank’s deflationary comments and finally, the worse than expected jobless claims number. The following factors are deflationary and the U.S. equity markets are rejoicing.
I would ask the question, “Have the preceding factors created a bottom in the economic cycle or, are we seeing a more general global slowdown?” I believe that the domestic economic issues have not been addressed and that a globally deflationary environment will create more problems for the U.S. Dollar than it will solve.
First, examine the chart on import prices. The double top may have proven to be the limit. Clearly, it has already begun to turn down. This index includes oil which, when priced separately, is 5% higher than imports in general. Oil is germaine to the topic because the $25+ decline has NOT been priced in and will contribute greatly to the establishment of this chart’s double top.
If, in fact, overall commodity prices are topping out then, this will also reduce demand for U.S. commodity exports. Exports have helped to offset the declining Dollar over the last two years as global demand and globally anomalous weather patterns have made the U.S. the supply center for the world. Dollar strength and, or a global slowdown will curb the primary growth engine for the U.S. economy. What effect will this have on a sluggish employment picture?
Obviously, the unemployment pressure is still to the upside. Will global commodity deflation offset the cost of a declining employment base? According to many pundits, the tax refund checks have gone to cover current expenses, rather than paying down debt. That leaves many people still looking for meaningful employment opportunities. This is most clearly illustrated in this week’s jobless claims.
The past two weeks’ claims have surpassed the historically significant 450,000 threshold. As you can see from the chart, this threshold is frequently accompanied by a recession. Based on the previous factors, I fail to see continued strength in the U.S. Dollar or, the U.S. economy. While the equity markets have broached the 20% bear market threshold and, recently bounced, I still view this as a selling opportunity in both equities and the Dollar.
It appears that this is beginning to be priced into the interest rate markets as well. Inflationary pressures are easing. This is taking the pressure off of the Federal Reserve Board to tighten rates at the next meeting on September 6th. Furthermore, the declining employment picture will add pressure to hold or, LOWER, rates at meetings through the end of the year. This stance is contrary to the hawkish inflationary stance that has been their premise for much of this year. Finally, the combination of a declining equity market in an election year would also add to the shift in the FOMC’s position from hawkish to dovish. The last chart is beginning to tip the market’s hand as it points to lower rates ahead……once again leading to a lower Dollar.