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"Maverick McCain" and the Resurrection of the US$Gary Dorsch "As soon as you think you've got the key to the stock market, they change the lock," lamented Joe Granville, who is mostly remembered for his bearish calls on the US stock market during the 1970's, 1980's, and the 1990's. Nowadays, many currency traders are scratching their heads, trying to figure out what's behind the sudden resurrection of the US-dollar, which is flexing its muscles for the first time in two-years, and defying conventional logic, by climbing sharply higher against most foreign currencies, including those that offer much higher rates of interest. The Euro has plummeted 12% vs the US-dollar since July 15th, tumbling to as low as $1.410 today. Earlier this week, Euro-zone Finance chief Jean-Claude Juncker gave currency traders the green-light to trash the Euro. "Things are developing in the right direction, in line with the commitments of the US Treasury that it stated in recent months. The Euro is less than $1.44, and it reflects economic fundamentals better than the Euro flirting with $1.60. I still think that the Euro is overvalued, not only against the dollar, but also against other currencies," he said. There's been a major shift in market psychology surrounding the US-dollar, that's caught many currency traders by surprise. Until July 15th, the key driver fueling the Euro's historic advance against the US$, was a widening interest rate advantage. In Frankfurt, Germany's 2-year yield rose to as high as +220 basis points above the comparable US-T-note in June, and up sharply from a negative -80 basis points in April 2007, which in turn, guided the Euro on a steady climb higher to $1.600.
Today, the German 2-year schatz still commands a hefty +165 basis point advantage over the US-T-note, which just a few months ago, was sufficiently high enough to buoy the Euro within a tight range of $1.540 to $1.600 in the second quarter. And there's no indication that the Euro's wide interest rate advantage over the US-dollar is about to shrink in the months ahead, neither by a series of rate cuts by the ECB, nor by a series of rate increases by the Fed. On Sept 4th, ECB President Jean-Claude Trichet ruled out a rate cut anytime soon. "We just increased interest rates in July to 4.25%, to deliver price stability during the course of 2010. We never pre-commit, and we always do what is necessary to maintain price stability. At face value, today's press conference should have dispelled any rate cut speculation for some time," he warned. On the flip side, the Fed won't raise rates after the US economy lost 84,000 jobs in August, and the jobless rate jumped to 6.1% in August, a 5-year high. The US economy has shed 610,000 jobs for eight straight months, something that has happened only eight other times since the end of the World War Two. In each instance, the string of job losses signaled a US economic recession. Worse yet, eleven US banks have failed so far this year, and the FDIC classified 117-banks as a "problem" in the second quarter, up 30% from Q'1. Nearly 1.2 million US homes are in foreclosure, weighing on a fragile market, with no bottom in sight for home prices. "You simply must accept that the credit crisis is far from over," warned Federal Deposit Insurance Corp chief Sheila Bair on Sept 4th. She urged banks to strengthen their reserves. "It's a tough slog but there's no easy way out," she said.
Bair expects more US bank failures which could exceed the FDIC's $45 billion insurance fund. However, she noted the FDIC can tap into a $30 billion long-term line of credit with the US Treasury Department and up to $40 billion of short-term credit. Yet even a rash of US bank failures and the swirling crisis engulfing Lehman Brothers, LEH, Wall's Street's fourth biggest investment bank, hasn't put a dent in the US-dollar's newly minted Teflon armor. Lehman's 8% preferred-J shares plummeted to $8 per share, lifting its junk-status yield to 25%, after an eleventh-hour rescue attempt by the Korea Development Bank (KDB) was placed in doubt. True to form, the credit rating agencies are still touting LEH's credit status at single "A" even though the company is essentially locked out of the credit markets. The cost of protecting Lehman's debt with credit default swaps for five-years rose to 590 basis points, or $590,000 a year to protect $10 million of debt, up from 325 basis points the previous day. When a bank loses the confidence of its customers, it can evaporate very quickly, just like Bear Stearns. During the Bear Stearns crisis, the cost of insuring its debt only went up to 450 basis points. Odds are Lehman won't be the last major US bank pushed to the brink. Less than 48-hours earlier, the US government seized mortgage giants Fannie Mae and Freddie Mac, after it discovered they had cooked the books, and didn't hold sufficient capital to cover their losses. Arab Oil kingdoms Rescue the US-dollar Yet despite all this negative news for the US-dollar, currency traders are putting a positive spin on whatever mud that's thrown at the greenback. What's behind this sea-change in market psychology towards the US-dollar, where the focus has shifted away from interest rate differentials, and instead, has veered-off towards other key factors? They are several reasons that are beyond the scope of this article, but were highlighted in the August editions of the Global Money Trends newsletter.
Throughout the US-dollar's tortuous 40% slide over the past six-years, the Arab oil kingdoms in the Persian Gulf stayed loyal to their archaic US-dollar pegs, even while the Fed's indifference to the sliding US-dollar sent inflation shock waves through their dollar-linked economies. Saudi Arabia was forced to expand its M3 money supply by more than 20% in order to defend the dollar peg, which in turn, fueled inflation to +11.1% in July, it's highest in 30-years. In Abu Dhabi, the biggest member of the UAE federation, prices were 12.9% higher in June. The Arab oil kingdoms rescued the US-dollar from the brink of collapse, by rapidly expanding the supply of Kuwaiti dinars, Saudi riyals, and UAE dirhams, and then recycled about $250 of Petro-dollars into US Treasuries over the past 12-months, through their brokers in London. In return, the US armed forces are defending the Arab Oil kingdoms from their dangerous neighbors to the north in Iran, which seeks nuclear weapons, and is closely aligned with czarist Russia, and Venezuela's mercurial kingpin Hugo Chavez, - forming the "Axis of Oil."
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