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The Return of Foreign Currencies

jhaddock (July 30, 2009)

Thursday, July 30, 2009

What’s Next for the European Majors Now that Risky Assets Are Back

By Chris Gaffney Hope everyone made it through the ‘hump day’ with no worries. Lots to cover today, so let’s just get right in…

The dollar has been gaining ground over the past couple of days due to ‘safe haven’ demand as traders rushed from the riskier assets.

But a surprisingly strong durable goods number (minus autos) combined with an ‘all clear’ signal from President Barack Obama had investors moving back into riskier assets yesterday.

Overall, that’s bad news for the dollar and great news for most major currencies. But more on where the currencies stand in just a minute. First, let’s break down what’s triggering this move back into riskier assets including foreign currencies…

Currency Champion #1: Stronger Durable Goods

Let’s talk about durable goods first. When the number was first released yesterday morning, it actually showed a pretty dramatic drop of 2.5% compared to May.

But the overall number includes automobiles. Considering plenty of big 3 automobile plants shut down for part of June, the markets were ignoring the transportation part of the durable goods numbers this month.

Nobody Is Counting Cars….

If you don’t include automobiles or aircrafts, then orders for durable goods rose 1.1% in June following an adjusted 0.8% rise in May. That “non-autos” number was strong enough that market participants reasoned that companies will start boosting output in the coming months.

While the 1.1% jump in orders is nice to see, the overall drop was still pretty dramatic. Not to mention, the auto sector makes up a large percentage of overall output for the United States. In other words, I wouldn’t be popping the champagne yet.

Currency Champion #2: President Obama

As I mentioned, the nation’s #1 cheerleader was out in full force yesterday afternoon. President Barack Obama defended his administrations policies during a speech in North Carolina.

President Obama’s poll ratings have slipped as unemployment continues to be a drag on consumer confidence. So he took a break from pushing his health care reform to defend his economic policies. President Obama said he had helped avert an economic disaster as the U.S. economy was in a “freefall.”

He stated that the U.S., “may be seeing the beginning of the end of the recession” and that his stimulus plans had “helped stop a recession from becoming a depression.”

Again, that remains to be seen. But for yesterday anyway, his words were enough encouragement to push traders back into riskier assets. That includes most of the major currencies, as traders dumped their safe haven dollars for higher-yielding currencies abroad.

Now that you have a clear picture of what’s pushing up currencies…let’s take a look at where the European major currencies stand after yesterday’s rush towards riskier assets.

Pound Is Rallying, But Storm Clouds Are Coming Next

The British pound was one of the biggest gainers vs. the U.S. dollar yesterday. A report showed U.K. house prices rose in July for a third consecutive month. Another report showed the average cost of a home in the U.K. rose 1.3%.

The pound will probably end up in positive territory vs. the U.S. dollar this month for a fifth consecutive monthly gain. The rally is a relief for pound sterling investors as the currency dropped more than 26% vs. the U.S. dollar last year.

A Standard Chartered PLC analyst predicted further strengthening for the pound sterling. The analyst said the U.S. dollar is in a multi-year downtrend, and the pound will likely push up to $1.75 by year endyear-end.

But there is still the question of deficits in the United Kingdom. The BOE was one of the first central banks to institute ‘quantitative easing’ policies. Many are looking for them to be the first to stop the program. With the U.K. housing sector stabilizing, officials will likely pause the asset-purchase program which was set up to lower borrowing costs.

But the U.K. is still going to have to deal with a record deficit. The U.K. Treasury said it will sell a record 220 billion pounds of debt in the year ending March 2010 to offset falling tax revenues and increased government spending. Again, good news for the pound in the short term, but the storm clouds are still gathering.

The “Experts” Are Saying Buy the Euro…I Say Be Cautious

Positive news out of Europe this morning has helped keep the euro moving up in early trading. European confidence in the economic outlook increased more than economists forecast in July. The reason? An index of executive and consumer sentiment climbed to the highest reading since November.

Both Morgan Stanley and BOA/Merrill Lynch told investors to sell the dollar vs. the euro in research reports released yesterday. Morgan Stanley said investors should sell the dollar against the euro, Norwegian krone, and Canadian dollar as the global outlook improves. BOA raised its forecasts for the euro predicting it would rise to $1.50 by year-end.

But the economic recovery in Europe is still very fragile. You could see that in another report released this week, which showed retail sales fell for a 14th month in July. Unemployment in the Euro region continues to be a concern, with the unemployment rate expected to reach 12% in 2010.

The Central Bank Squashed the Swissie…Just Like They Planned

One currency ,which hasn’t been performing well vs. the U.S. dollar recently, is the Swiss Franc. The Swissie has been one of the few currencies to drop vs. the U.S. dollar over the past month.

This is exactly what the Swiss National Bank has been trying to accomplish, as they have spent as much as $32 billion since March to keep the Swiss franc from appreciating.

The Swissie continues to be a popular choice for investors, but problems with Swiss banking and the government intervention will likely keep the Swiss franc from rallying dramatically. However, no central bank (not even the Swiss) has enough money to fight the currency markets. The markets will eventually win out, and the longer-term prospect for the Swiss franc is still positive.

It is just that there are other currencies whichcurrencies, which have better prospects in the near term…

Kroner and Krona Continue to Climb: Here’s What’s Next…

Norway is one such currency. Norway’s central bank will likely be one of the first among the world’s richest economies to begin raising rates as the global crisis shows signs of abating. Inflation in Norway is likely to increase past the Norges Bank’s target, increasing pressure for Norway’s central bank to hike rates.

The markets are beginning to price in an increase in rates as the Norwegian economy starts to heat up. Oil revenues, and a conservative fiscal policy helped to soften the impact of the global economic crisis, and Norway is now set to be one of first European economies to recover.

Retail sales in Norway were up 2.6% in May since March and underlying inflation accelerated to an annual 3.3% in June, the fastest pace in eight months. The housing market in Norway is also pushing the recovery, as property values rose 5.3% in the three months ended June, the second quarterly gain.

Norway’s neighbor, Sweden, is another currency, which has been performing quite well vs. the greenback. The Swedish krona is second only to the Australian dollar in return vs. the dollar over the past week. The krona is also among the top three currencies this month.

Sweden’s krona is benefitting from a jump in exports. Sweden’s trade surplus almost doubled in June as exports to Europe and the U.S. increased. The Swedish krona has also benefitted from recent IMF support of the Baltic region, where Swedish banks are heavily exposed.
To quickly recap: Riskier assets and currencies are making a comeback. A handful of the European majors offer some real opportunity right now including the Norwegian kroner.

Hope everyone has a Tub Thumping Thursday!!
Chris Gaffney, CFA

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