Negative Economic Data Worries Investors

The dollar continued to gain strength throughout Tuesday, but gave back some of these gains overnight. The big story yesterday was the downgrade of Greece’s debt rating by Fitch Ratings, and warnings of possible rating downgrades for the US and UK. The sell off in oil has also weighed on some of the commodity-based currencies, but I’ll start today’s Pfennig with some data releases.

Japan’s economy expanded less than a third of the pace initially reported as companies slashed spending. GDP rose an annualized 1.3% in the third quarter, substantially slower than the 4.8% pace reported last month. Price declines in Japan also accelerated, adding to worries that Japan will not be able to shake off stubborn deflation. Prime Minister Hatoyama blamed a stronger yen (JPY) for the slower growth, adding to the concerns that the government may step in to counter the recent appreciation. Japan has a long history of currency manipulation, so these concerns are legit. Investors who still own the yen may want to look to lock in gains, as officials will likely stem any further gains in order to keep their economic recovery moving forward.

German industrial output unexpectedly fell for the first time in three months in October according to a report released in Berlin. Factory orders fell for the first time in eight months in October, the ministry said yesterday, raising questions about the recovery’s staying power. UK manufacturing also stalled out in October coming in unchanged after gaining 1.5% in September. Economists had predicted a 0.4% increase. BOE policy makers will likely maintain their ‘quantitative easing’ plan well into 2010 in order to try and spur the UK economy. Chancellor Darling said yesterday that he would rather risk inflationary pressures of keeping support going too long than cutting off the nascent recovery.

This data helped push the dollar up versus the euro (EUR) and pound sterling (GBP) as investors began to question just how solid the recovery in Europe would be. But the big story hitting the news wires yesterday (besides Tiger’s mother in law) was the downgrade of Greece’s debt. Fitch cut its rating on the nation’s debt to BBB+ and the two other major rating companies are threatening to follow. The airwaves were filled with pundits warning that Greece would by the first EU default in 60 years when Germany defaulted. But Greece will benefit from being part of the European Union, and EU officials calmed the markets yesterday afternoon, stating that they would lend their support to help Greece with its budged deficits.

The bigger story, in my opinion, was Moody’s warnings that the US and UK could lose their AAA ratings. Moody’s warned that worsening public finances in both the US and UK could force a downgrade of these two countries. The rating agencies warned both countries about their growing deficits, something Chuck has been warning investors about for years now. While I am happy these ratings companies have finally ‘seen the light’ on these free spending administrations, their credibility was all but lost during the credit crisis. As always, these rating agencies are a bit late to the game, and are stating the obvious.

US manufacturers are certainly enjoying this year’s dollar sell off, and have a much more optimistic outlook for sales in 2010 than their service industry counterparts. As Chuck has written, the US economy has moved away from actually making things toward a service based economy over the past several years. A weaker dollar and a growing middle class in China should help the US manufacturing sector. Purchasing managers at US factories anticipate sales will grow 5.7% next year, easily exceeding the 1.3% gain projected by service companies. The service sector currently makes up nearly 90% of the US economy, so a shift back toward manufacturing should be helpful.

Our friends at PIMCO posted a great article on their website yesterday evening telling investors to “fear not the falling dollar”. Scott Mather, head of global portfolio management wrote, “A gradually weakening dollar may help heal the US economy” by encouraging demand for the nation’s exports. But Mather believes the dollar will maintain its role as the world’s reserve currency and that the dollar decline will not add to inflation. The report calls for the US currency to continue to slide as the Federal Reserve keeps US interest rates at a record low, encouraging investors to look overseas for higher yields.

But there are still those who feel the dollar will gain over the next year. Technical traders over at Barclays Capital told investors that the dollar index might extend gains to a three-month high of 77.69 after it rose above a minor resistance level. Yesterday’s move above 76 was the first time the index had closed above that figure since April.

The following was spotted by Ty Keough yesterday and includes a great quote by his friend Porter Stansberry. A reader sent an email to Porter stating that since everyone seemed to be bearish on the dollar, he is looking to go against the crowd and buy the US dollar. Porter wrote this in response:

“Good luck with that trade… Before you lever up, you might ask yourself what the Fed is going to do when another $1 trillion worth of home mortgages blow up this year… When $1 trillion worth of commercial mortgages come due in 2011… When China decides to stop buying Treasuries… And when GE can’t refinance in 2012. The US dollar is a one-way bet, my friends.”

Porter is always dead-on with his comments, and I appreciate Ty bringing this quote to my attention. A reader sent me another good quote yesterday: Morgan Stanley’s chief Asian economist Andy Xie said Federal Reserve Chairman Ben Bernanke is prescribing ‘poison’ to the US economy by keeping rates near zero. In an email released yesterday, Xie said that Bernanke is fueling a wave of speculative capital that may cause the next global crisis. Bernanke is making decisions based on ‘marginal considerations’ that will help short-term growth and employment instead of focusing on the ‘soundness of the system’. I share Xie’s opinion, and worry that our current administration seems to be wanting to get things back to what they were a few years ago. The problem with this is that ‘easy money’ is exactly what put us in this situation, and the re-inflating of these asset bubbles will only set us up for another pop!

The recent sell off in oil has added to the selling pressure on the Mexican pesos (MXN), Canadian dollars (CAD), and Brazilian real (BRL). Brazil’s currency declined for a third day, but is still the best performer versus the US dollar YTD. At least some of the sell-off in the real can be attributed to investors securing profits on the real which is up over 30% versus the US dollar during 2009.

The Canadian dollar also fell as the Bank of Canada kept interest rates unchanged and warned that the currency’s strength against the US dollar would likely hurt economic growth in 2010. But Canada has strengthened their export ties with China, and the growing middle class in China should help offset some of the lost exports to the US. The Mexican peso fell the most in two months following another drop in crude oil. But the economic recovery in Asia will continue to support oil prices and I would expect both the loonie and peso to rebound as soon as oil turns back around.

The Russian ruble extended its steepest slump in almost 10 months as oil traded below $73 a barrel. While we don’t trade the ruble, it is one of the four currencies involved in our BRIC MarketSafe CD. Speaking of the BRIC, we will be setting the hedge on our last BRIC CD today, so investors will actually benefit from this recent dollar strength. This last BRIC is not as large as our first two issues, but was still well received. Chuck tells me he is working hard on coming up with another MarketSafe idea for the beginning of 2010. Stay tuned….

We have a number of investors sitting on the sidelines waiting to see if this dollar rally will have legs. I think it is smart to watch for cheaper prices, but don’t let this temporary dollar rally talk you out of investing into the currencies. I believe the best method is one of cost averaging, which entails placing a set dollar amount into the market on a regular basis. This way, you are purchasing more when the dollar is strong, and less when the dollar is weak. Timing is important, but being diversified into the foreign currencies and metals should continue to be your goal. Don’t get caught standing on the sidelines while the currency markets turn around.

To wrap up… Negative economic data worries investors, Fitch downgrades Greece (could the US or UK be next?), and oil prices cause a sell-off in some of the commodity currencies.

By Chris Gaffney

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