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Are Recession Fears Driving the US Dollar and Equities Lower?

Wed, Oct 15 2008, 07:18 GMT
by Kathy Lien

GFT

The feel good factor in the markets was relatively short-lived with the 400 point rally in the Dow this morning turning into a more than 75 point decline by the end of the US trading session. The US dollar weakened against every major currency but the reversal in the Dow has caused the greenback to recover some of those losses. Given that the Dow saw its largest point gain ever on Monday, a correction would be natural. However, in this fickle and unsteady market environment where investors are not sure how hard they should be pushing the buy button, any significant correction will leave investors extremely insecure about being long stocks. The currencies that will be impacted the most are the US dollar and the Japanese Yen because continued weakness in equities has been helping the dollar but hurting the Yen.

Is Earnings Season Bringing Back Recession Fears?

With the third quarter earnings season in full swing, the latest correction in the stock market is partially attributed to the fears of a recession. Former US Fed Chairman Paul Volcker said on Tuesday that there is a risk of a considerable recession in the US and Europe. We find the debate of a recession quite interesting because talking about whether a recession is here or not is just a matter of semantics. Everyone from individuals to corporations large and small is already acting like a recession is here. In fact, not many people would argue that the US economy is in the worst shape since the Great Depression. Over the past 50 years, there have been 6 times that the US economy has fallen into a recession and to be compared to the Depression at a time when we have yet to see two consecutive months of negative GDP growth indicates the potential of addition weakness for the US economy. So far, third quarter earnings have been soft, forcing many companies like Pepsi to cut jobs. In the second quarter, many multinational US corporations benefitted from positive currency translations. The dollar’s weakness boosted their overseas earnings helping to contribute to the company’s profitability in the second quarter. However the 15 percent rally in the US dollar over the past 3 months will erase any positive currency contributions, increasing the chances of earnings reports missing expectations. This is part of the reason why rating downgrades by Standard and Poors has hit a 6 year high. Taking a step back, it would be surprisingly if the credit crisis and the meltdown in stocks did not lead to a major slowdown in the global economy. With retirement accounts falling as much as 40 percent in value over the past month, individual and corporations will increasingly become more frugal especially going into this holiday shopping season which could lead to more troubling times for the US economy. Recessions fears are real and will remain for some time.

Details on the US’ Recapitalization Plan

The price action in the equity markets today may continue to be the classic “buy the rumor, sell the news” reaction to the Treasury’s Recapitalization plan. This morning, Treasury Secretary Paulson announced a $250B program that would inject half of that amount into 8 of the country’s largest financial institutions and leave the other available to any bank or bank holding company that needs it. The US government has taken an equity stake in the banks and will be privy to dividend payments on their preferred stock. Based upon the tone of Paulson’s press conference, he was extremely reluctant to resort to this option but unfortunately, he felt that to not do so would leave US citizens and businesses “without access to financing,” which is “totally unacceptable.” The FDIC announced that they were guaranteeing all deposits regardless of size in non-interest bearing accounts through 2009. This means that all checking accounts that do not pay interest are covered in case the bank fails but there is still a $250k limit on interest bearing or savings accounts. In taking these actions, the US government has basically pledged to prevent another major bankruptcy and even if a bank of any size fails, consumers are protected as long as their money is held in a non-interest bearing account.

Watch Out for Retail Sales

A number of important US data are due for release tomorrow including retail sales, producer prices, Empire manufacturing, business inventories and the Fed’s Beige Book report. Both ICSC and SpendingPulse have reported a decline in consumer spending so we expect the retail sales to be weak. Import prices also took a big tumble, which should lead to softer producer prices. Overall we expect most of the economic data to be dollar bearish. The same is true for the Fed’s Beige Book report as the US economy weakens and inflation eases.

Published on  Wed, Oct 15 2008, 07:19 GMT