The USD recovered from 2009 low in Tuesday's trade supported by a spike in risk aversion as the IMF warns that the global recovery may be sluggish. Uncertainty about the strength of the global recovery may temporarily limit selling of the USD but the underlying downtrend for the US will likely remain intact. Speaking in New York Monday, Fed Chairman Bernanke pledged to maintain low yields for an extended period and appeared to suggest that if unemployment continues to rise the extended period of low yields may be longer than anticipated. The Fed chairman linked the timing of the Fed's exit strategy to employment outlook and price stability. Bernanke said that he expects a less than a robust economic recovery and warned that rising unemployment and tight credit conditions remain headwinds to growth.
Tuesday, the US reported that core wholesale prices posted an unexpected drop of 0.6%. The drop in the core PPI suggests that deflationary pressures may be more of a near-term risk than inflation and the Fed's concern about price stability will be overshadowed by US employment outlook. Mid-November the US reported that Q3 GDP growth was 3.5%. The stronger than expected rise in US Q3 GDP helped fuel optimism about the US global recovery and was an additional trigger for the current rise in commodity prices, equities, the improvement in risk appetite and drop in value the USD. The Feds Fisher says that US Q3 GDP will probably be closer to 2.5% when revisions are taken into consideration. A Philadelphia Federal Reserve Bank survey of economists finds that US economists have cut their 2010 US growth outlook and outlook for the labor market. The Philadelphia Fed survey says that economists have cut their 2010 US GDP growth forecast to 2.3% from 2.5% and expect the second quarter GDP at 2.4% compared to original forecast of 2.8%. According to the Philadelphia Fed survey economists see the job outlook deteriorating in the fourth quarter 2009 and into the first quarter of 2010 with employment expected to improve in Q2 2010. Historically jobs growth tends to pick up as the economy emerges from recession but some economists are concerned that the US may be facing a jobless recovery. New York University economist Roubini warns that the worst is yet to come for the US employment outlook. Roubini expects job losses to continue until the end of 2010 at the earliest and says that many US jobs are gone forever including construction jobs finance jobs and manufacturing jobs. He notes that the ratio of job to vacancies is 6 to 1 and the average length of unemployment is at all-time high. Roubini expects US unemployment to peak around 11% and stay elevated for two years or more. Labor market weakness points to an anemic US recovery. Roubini calls for bold action to create jobs that includes fiscal stimulus and temporary tax credit to the private sector to hire more workers. Speculation about additional fiscal stimulus may be a catalyst for the next down leg in the USD.
The implications for the USD from IMF warning about the risk of a sluggish global recovery and Bernanke's comments depend on how central banks and governments react to the outlook for the global economy. The price of gold traded at a record high Monday, US equities traded at new highs for 2009 the USD sank to its lowest level since mid-2008 as central banks and governments around the world pledged to maintain fiscal and monetary stimulus. Fed Chairman Bernanke was asked about the risk that these policies may be creating asset bubbles. His response was that it's inherently extraordinary difficult to know whether an asset price is line with fundamental value and that is not obvious to him that there are any large misalignments currently in the US financial system. In light of today's drop in US core PPI Bernanke may be correct but it is important to distinguish between markets driven by demand factors like wholesale goods and assets often bought on margin like stocks commodities and currencies. Monday Forbes carried a report which suggests that there is no empirical evidence that markets are being solely driven by liquidity. On the same day Forbes carried an article that says a weak USD and low yields have created a huge carry trade that is having massive impact on global asset prices and boosting speculative investment in stocks, commodities and property markets.
USD recovery Tuesday was also partly attributed to what has been loosely labeled verbal intervention in support of the USD. In his speech Monday, Bernanke said that Fed policy would help ensure that USD is strong and a source of global financial stability. Last week Treasury Secretary Geithner said strong USD is in the best interest of the US. These efforts at verbal support of the USD will have limited impact as focus returns to Fed policy outlook and uncertainty about the US recovery. Part of the verbal support for the US may have been related to President Obama is trip to China and geared towards reassuring China that the US plans to tackle its deficits. China holds an estimated 1.7trln in US debt. US budget deficits are projected to top 1trln a year over the next decade. The US needs GDP growth of at least 5% to support its rising debt load. As noted above economists expect US GDP to fall far short of 5%. Chinese officials have numerous times over the course of 2009 expressed concern about the outlook for the USD and the value of their US debt holdings.
Today's USD rebound will likely be short-lived. The underlying negative USD theme should continue as investors track low US yields and speculation reemerges that the US has little choice but devalue the USD to try to inflate its way out of debt. In addition, the USD remains vulnerable to global trade imbalances and China's reluctance to break its Yuan peg. China has kept its currency pegged at 6.83 to the USD since July of 2008. The decision to keep the Yuan pegged at this level was mainly in response to the global financial crisis and to help China's exporters weather the global economic downturn. Over the weekend US officials pressured China to allow the Yuan to appreciate to help rebalance global trade but China rejected US pressure on the weak Yuan. Keeping the Yuan pegged not only helps China's exporters but partly offsets the impact of weakening USD on China's US debt holdings. This may partly explain the continued reluctance of China to allow the Yuan to rise despite signs that the global economy is emerging from recession.