Fresh concerns about the global economy have triggered sharp gains in the US dollar and the Japanese yen. Risk aversion continues to seep through the markets as the National Bureau of Economic Research finally admits that the US economy fell into recession in December 2007. The first trading day of the last month in the year has been exceptionally brutal with the Dow Jones Industrial Average falling more than 635 points or 7 percent. Even President Elect Barack Obama’s nomination of Hillary Clinton as Secretary of State has failed to help the markets.
Dollar Remains the Safe Haven Play, Bernanke Signals More Rate Cuts
There is no question that the meltdown in the equity market singlehandedly triggered the sell-off in the currency market today. Most people knew that the US economy was already in recession, but as reality hits with the official NBER announcement, investors bailed out of equities once again. In fact, we have seen a global flight to safety today with stock exchanges across Europe slipping more than 5 percent. The flight to safety has led to repatriation back into US dollars even though there is still more trouble ahead for the US economy. On day when manufacturing indexes across the globe hit decade to record lows, the US Federal Reserve was the only central bank to offer practical reassurance. Fed Chairman Ben Bernanke said in a speech today that further interest rate cuts are certainly feasible and even though their scope for conventional rate policy is limited, their other options include buying long term Treasuries or agency securities in substantial quantities.
Cyber Monday May Not Save the US Economy
Investors are looking to Cyber Monday in the hopes that retail sales may support the economy but even if consumers spent more this year than last, it is a result of discounts rather than underlying demand. Foot-traffic at the nation’s retailers on Black Friday was stronger than expected but many forecast that because the discounts were so deep this season, often reaching more than 50%, increased sales will not transfer into strong profits. The shopping event that transpired last Friday was more of an act of desperation by retailers than anything else. Industry groups, such as the National Retail Federation, note that weekend traffic fell-off significantly as buyers felt satisfied that they took advantage of all available discounts during Friday’s rush. In addition, more shoppers indicated that they were already done with their holiday shopping this year than last. Buyers also specified that gift purchases will be constrained to the younger audience, with older friends and family agreeing to forgo adult gifts. This type of behavior suggests that the momentum may be difficult to sustain for the remainder of the month.
Dollar Rally Should Continue
This is the week where the problems in the US economy will come to forefront as reality sets in and investors realize the US is still in big trouble. If the data is as bad as we expect, the dollar rally should continue. We said often that recession trades such as short EUR/JPY and USD/JPY should thrive in this current environment and that is exactly what we have seen today. Contributing to the sell-off in US equities was the ISM manufacturing report which fell to a 26 year low. Every single subcomponent of the report either declined or remained unchanged with big drops seen in the prices paid and employment components. As we week progresses, we will be looking at the leading indicators for non-farm payrolls for clues on the degree of job losses in the month of November. The manufacturing ISM report suggests that the sector will see its 29th consecutive month of job losses. The fate of the Big 3 automakers will play a central role in determining whether this continues.