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Daily Market Commentary

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How Does the US Dollar Perform in a Recession?

Wed, Dec 3 2008, 08:50 GMT
by Kathy Lien

GFT

It is a challenging week for the financial markets and today’s recovery in equities is characteristic of a bear market rally which is why the dollar managed to hold onto its gains against every major currency except for the Euro. As the only currency that appreciated more than 20 pips against the US dollar, there is little to explain the Euro’s strength other than a clear decoupling from commodities. Since the beginning of the year there has been a 70% positive correlation between the EUR/USD and oil prices but now we are seeing the correlation break down as oil prices hit a 3 year low.

How Does the US Dollar Perform in a Recession?

Counting the current one, there has been 3 recessions in the past 30 years. In each of those recessions, the dollar weakened in the first six months of a recession, then gained strength in the next six. Twelve months into this current recession, we see this pattern in the dollar repeated. The next question to ask is whether there is a pattern in the way the dollar performs in the second year of a recession. Taking a look at how the dollar traded in 2001, the 1990s and the 1980s, we see no consistent trend but that is only because the 1990 and 2001 recession only lasted 8 months. The current recession can only be compared to the one in the 1980s and based upon how the dollar performed then, we could expect a near term top in the US dollar in the first half of 2009. In 1981, halfway through the 2 year long recession, the US dollar index plunged more than 7.5 percent before recovering and taking off once again. We could see that pattern repeated in 2009.

Trouble for Automakers

The big focus in the financial markets today was automakers. The Big 3 are back in Washington presenting their plans to Congress in the hopes of securing $25 billion in federal loans. Their financial situations have become more severe since their last visit and perhaps today’s monthly sales figures will sway some members of Congress. General Motors, Ford and Chrysler all reported that sales fell at least 30 percent in the month of November with Chrysler being hit the hardest as US car sales dropped 47% last month. These steep declines will push these automakers closer to bankruptcy, leaving Congress with a tough decision. If Washington does not grant the $25B loan to the Big 3 automakers, the announcement could send equities below its five year lows. This would weigh heavily on the entire currency market and poses big risks for the US economy which is why we believe that it is not a gamble that Congress will not take. This may be part of the reason why US equities recovered after having turned negative at one point following the release of the vehicle sales figures.

Traders Shrug Off More Layoffs as Fed Extends Emergency Loan Programs

With non-farm payrolls on the calendar this week, traders should be particularly sensitive to any reports pertaining to health of the labor market. JPMorgan announced this morning that they will be laying off 9,200 jobs at Washington Mutual Bank. There are also talks that 10,000 jobs could be cut from Bank of America, mostly from Merrill Lynch. The labor market is in bad shape and likely to get worse even if we do see a blowout number on Friday. The most important leading indicators for non-farm payrolls are due for release tomorrow, which are the Challenger job cuts report, the ADP employment change and service sector ISM. If we see all around weak numbers, then it is almost certain that non-farm payrolls fell by more than 300k last month. The stock market however did not give the layoff announcements a second thought as the Federal Reserve continues to take steps to mitigate a deeper credit crisis. They extended 3 of their emergency loan programs by 3 months as the credit markets remain tight. The Beige Book report is also due for release tomorrow and we expect the Fed districts to vocally confirm what the economic data has been showing which is that the US economy is in trouble.

EUR/USD: BUCKS THE TREND DESPITE WEAKER DATA

The Euro bucked the trend today by gaining strength against the US dollar today despite weaker economic data. Eurozone producer prices plunged 0.8 percent, the largest drop in 22 years. The decline in inflationary pressures should give the European Central Bank the flexibility to make a larger interest rate cut on Thursday but it remains to be seen whether the ECB will make a 75 versus 50bp rate cut. Economists are also split with most calling for a smaller move. Anything larger than a half point cut would be biggest for the central bank since their inception in 1999. Eurozone retail sales and the final figures for service sector PMI are due for release tomorrow. Given the sharp drop in German retail sales, the regional index should see a substantial decline as well. Switzerland also saw a sharp decline in consumer prices, which opens the door for the Swiss National Bank to take interest rates to zero. The resilience of the Euro suggests that if equities extend their gains on Wednesday, the Euro could outperform its peers.

GBP/USD: ALL PMI REPORTS ARE AT RECORD LOWS

The British pound remains weak as the United Kingdom continues to report that their economic data has hit record lows. Yesterday it was the manufacturing PMI index and today it is construction sector PMI, which slipped to 31.8 from 35.1. Tomorrow we are expecting service sector PMI which is already at a record low. All three of the PMI reports are in contractionary territory reflecting the dire situation of the UK economy. The Bank of England is expected to cut interest rates by 100bp on Thursday and the price action of the British pound suggests that traders are positioning for that. The central bank has been relatively muted about the weakness of the currency. There is a good reason for that since its depreciation helps to cushion the UK economy. Australia is a perfect example. A lot of exporters and multinational companies in Australia have raised their earnings forecast thanks entirely to the weakness of the Australian dollar. Combined with the proactiveness of the central bank, we expect the UK economies to be one of the first to turn around when the dust settles.

Published on  Wed, Dec 3 2008, 08:52 GMT