The U.S. Dollar rose to its highest level in three years on Friday on concerns that the global recession and financial turmoil was worsening, the third bailout of Citigroup by the U.S. government and an outright demand for safety. It is very clear that there is a tremendous central bank need for U.S. Dollars to fund economic recovery activities. As the global economy worsens continue to look for central banks to seek more U.S. Dollars.
The demand for U.S. Dollars is a short-term event which is being triggered by a near-term panic. The world economy is heading down at a fast and furious pace. This is making fear and uncertainty the driving forces behind the decline. Based on this observation, continue to look for the U.S. Dollar to be a safe have investment until something dramatic happens to change this scenario.
There were three big stories last week that triggered the bearish scenario for the global economy while igniting the rally in the U.S. Dollar: the Citigroup buyout, Obama's new budget and the expanding deficit, and the downwardly revised U.S. fourth quarter GDP report.
Last week Citigroup initiated a plan for the U.S. Federal government to convert its preferred shares of stock into a 40% stake of common stock. Although not technically nationalization, it is too close for investors to distinguish from the real thing. It's just a matter of semantics at this time. The trend is moving toward full nationalization of troubled U.S. banks and investors do not like the idea of government running a major bank.
Economists are still mulling over the new budget proposed by President Obama last week. Some of his revenue projections seem unreasonable and unattainable which is leading a few of his critics to say that the budget was written by someone named Rosy Scenario. What is known however is that the budget deficit will explode upward to about $1.75 billion. Global investors like the budget because it puts U.S. Dollars in circulation.
Finally on Friday a U.S. government report confirmed that the contraction in the economy was worsening with no apparent bottom in sight. In January the U.S. estimated the 2008 fourth quarter GDP to decline at an annual pace of 3.8%. Before the report on Friday, economists changed their estimate to a decline of 5.4%. The actual number showed that the economy is expected to shrink at an annualized pace of 6.2%.
As mentioned earlier, the demand for the U.S. Dollar is short-term while all of the U.S. economic and financial system issues are longer-term. The problem is that no one knows when the short-term is supposed to end.
The EUR USD closed in a very weak position as Euro Zone financial issues piled up and aggressive short-sellers pressed this market lower. The key issues remain the rapidly contracting German economy, the deteriorating banking systems in Central and Eastern Europe and what to do with the weaker European Union nations.
It was reported last week that Germany's GDP declined at an annual rate of 2.1 percent. This assures a European Central Bank rate cut of at least 50 basis points at its next meeting on March 5. The problem with the shrinking economy is that tax revenues are falling at a time when the government is spending money to stimulate the economy.
The second major issue facing the European Union is the deteriorating Central and European banking systems. The survival of the EU is likely to be determined by whether the banking system in these two regions remains sound. Any downgrade in Central and Eastern European banks will expose the Euro Zone to loan defaults. This would then weaken Euro Zone banks to the point where they would be downgraded themselves.
Last week this issue was addressed by the World Bank, the European Bank for Reconstruction and Development and the Eastern European Investment Bank. These three banks promised $31 billion in aid to keep the Central and Eastern European banking systems sound. Hungary and Poland currencies rose on Friday after it was determined that their banks would qualify for the proposed relief.
Finally, the European Union has to determine what to do with the struggling members of the Union. On Sunday, March 1, an EU conference will be held to discuss the issue of providing financial aid to the weaker members. Nothing major is expected to come out of this meeting as it is supposed to be a precursor to the G-20 meeting in April. EU members will use the time however to show the rest of the world that they are concerned about their economic partners.
With the world aware of the economic problems in the region, the EU runs the risk of appearing to the world as a group that does not care about its weaker members. A failure to discuss the impending economic dangers developing in this area would bring up the question of how can the EU call itself a union if it will not do what it takes to hold itself together?
While the weight of any bailout will fall on the more financially sound members like Germany and France, the problem is that these countries are becoming too weak themselves and cannot provide aid to everyone with their hands out.
The consensus is that those seeking aid will have to prove to the Union that they are doing all they can to become financially stable. The EU may go as far as to order these weaker countries to put their finances in order. Don’t expect a blank check to bailout the weaker countries to come out of this meeting. Orders will be given, and orders will have to be followed.
The main reason why the EU does not want to hand out money is that it believes that the Central and Eastern European countries in trouble brought the problems upon themselves by borrowing too many Euros in an effort to rapidly attain a Western-style living standard too fast and too soon. This was a major gamble that failed. The EU may come out of this mess looking like the bad guy, but all it is asking is for someone to take fiscal responsibility.
The issue of providing aid to the weakest European Union countries is not going to go away overnight. This means that the threat of an EU breakdown remains real. However, there are a lot of ifs to deal with before one can say for certain that the EU is doomed.
If Germany decides to shore up its own finances first rather than help the weaker nations then the European Union could collapse.
If Austrian, Italian, Greek and Spanish banks default, for example, then the pressure will be on Germany to bail them out. Investors would most likely dump Euros if this happened.
If investment capital seeks the safest yield, then new money will flow into the safest government instrument. This will mean that little or no money will go into the emerging nations where capital is needed most. This would also cripple the economies of Central and Eastern Europe.
In my opinion scenario one is most likely to take place. This is an election year in Germany and promises will be made to keep the money at home. The German people will most likely vote against helping others.
Should we be worrying about the situation developing with the European Union? Absolutely, because of the lightning speed that spread financial crises fly around the globe. Everything today is interconnected in this one-world economy. I am especially concerned since the ECB's Trichet recently said There is no weak link of the Euro area and he's the guy that was raising interest rates as late as July 2008 when the other central banks were lowering rates aggressively.
Last week the British Pound topped on the daily charts and closed lower for the week. Although consumer confidence was held near its weakest level in 30 years, news that more than 40% of British mortgages may exceed the value of the homes attached to them by year end put pressure on the Pound.
Last week following the announcement of one of the biggest corporate losses in history by the Royal Bank of Scotland, the U.K. government revealed the Britain Asset Protection Scheme. This plan was created to insure banks against exposure to toxic assets. It also gives the banks some time to stabilize and shore up their capital bases.
One really smart move by the U.K. Treasury was to disallow the RBS the ability to write off from their taxes certain losses from toxic assets. This was a smart move because the U.K. had guaranteed RBS' assets. In no way should a bank get bailout money and be allowed to write off the very losses that triggered the bailout money in the first place. Let's hope the U.S. considers this kind of agreement.
The USD JPY closed higher for the week, driven by the relentless shorting of the Japanese Yen. The crumbling economy continues to be the main issue. Recent bearish economic reports can be interpreted to show the Japanese economy on the brink of an economic meltdown.
The Yen has definitely given up its role as a safe haven currency as it faces its worse recession in 50 years. Not only have the last traders unwound their carry trade positions, but recent reports have shown that Japan's GDP for the 2008 fourth quarter declined 12.7%. A report late last week proved the economy is worsening as it revealed a 10% decline in industrial output. Contributing to this loss was a tremendous decline in automobile exports.
While the U.S. Dollar continues to shine as the world's safest currency, problems with the Swiss Franc are only beginning. At this time the U.S. Dollar appears to be the only safe refuge from the growing threat of economic turmoil.
The deteriorating Swiss financial system is the main issue. Recently Swiss banks wrote off $50 billion in bad debt. This figure is expected to grow as Swiss banks are likely to face additional pressure from exposure to toxic banks in Central and Eastern Europe.
Not only is exposure to toxic assets a burden on the Swiss Franc, but the banking industry is also feeling the sting of the U.S. probe of tax cheats using the secretive Swiss banking system. Finally, investors are reluctant to go long the Swiss Franc out of fear of a government intervention. The Swiss National Bank stands ready to flood the market with cash in an effort to revive the economy by stimulating export demand.
The USD CAD surged to the upside on Friday as stock fund managers unwound hedge positions by buying U.S. Dollars and selling Canadian Dollars. These traders were initiated as part of an end-of-the-month strategy.
Weak demand from the U.S. is hurting Canadian exports. Lower prices for commodities such as crude oil, natural gas and lumber are also weakening the economy. Reports are beginning to show that more U.S. Dollars are leaving the country rather than flowing in.
A report last week showing that Canadian retail sales had dropped was one of the first indications that the recession was finally hitting the domestic economy. Traders expect the revised GDP report - to be released on March 2 - to show an annual rate of decline of 3.6%. The only conclusion that can be reached is that the Canadian economy is rapidly deteriorating.
The declining global equity markets are putting downside pressure on the Australian Dollar. Falling commodity prices are a drag on the economy. Because of the stagnant-to-lower growth pattern developing, speculators expect the Reserve Bank of Australia to slash its key interest rate by 1 to 1.5 basis points at its next meeting on March 3. Look for this market to continue to follow the direction of the stock market. Also be aware that the RBA may intervene in an effort to boost the Aussie, especially if volatility accompanies a sharp decline in price.
The NZD USD closed lower for the week as less demand for higher yielding assets was triggered by extreme weakness in global equity markets. Demand is also falling for exports because New Zealand's biggest Asian partners - China and Japan - have quit buying commodities because of problems in their own countries.
The charts indicate more downside pressure with the possibility of a decline to levels not seen since December 2002. Because of the worsening global recession, it is going to take more effort on the part of New Zealand to stimulate the economy. The Reserve Bank of New Zealand meets on March 12. Look for a combination of a stimulus plan and aggressive interest rate cut by the RBNZ in an effort to revive the economy. Like the Aussie Dollar there is always the threat of an intervention in order to prop up this currency. This is likely to occur if a downside break gets too volatile.
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