Litany of Bad News

Posted December 12, 2008

The weakening US dollar took centre stage as the auto bailout legislation fails to pass the Senate. Investors indicate some willingness to accept slightly higher risk in currency markets.

 

In the United States, the economic news continues to deteriorate which is resulting in a weakening of the dollar against benchmark currencies.  The US dollar has been a safety net in terms of risk for currency traders, but that is changing as it becomes apparent the recession is continuing to deepen.  This is happening despite billions of dollars being injected into the domestic economy. 

The bad news litany is keeping investor confidence low.  The US auto bailout loan legislation failed to pass the Senate.  There are differing viewpoints as to whether this is a good or bad decision, but the result has been a slumping of Asian stock markets upon receipt of the news.  The US trade deficit widened to $57.2 billion in October and that is in the face of declining fuel prices.  The US household savings rate has actually increased, which would be good news in normal times.  But under recessionary conditions, it means consumers are spending less which hurts the economy even further.  The retail sales data is expected to show a fifth month decline for November. 

What all of this has led to is a falling of the US dollar.  Investors were buying dollars in the past as a low risk investment in the middle of declining stock and bond markets.  Now there are two factors at play which is leading to investors turning to other currencies.  First is the economic decline described earlier in this article.  Second is the willingness of investors to once again take on more risk than they wanted in the past few months. 

The dollar weakened against the euro ($1.331); the British pound ($1.4983); the Brazilian real ($.4226); the Australian dollar ($.6705); the Japanese yen ($.0109); and the New Zealand dollar ($.5495). The weakening of the US dollar might be an early indication that currency markets are returning to normal though.  The past couple of months have seen wide swings in both currency prices and in equity markets. In normal economic times, investors are willing to assume a certain level of risk in order to make greater profits.  With trillions of dollars lost in markets during the last quarter of 2008, risk aversion has been the name of the game.  The dollar and the yen have ruled currency markets for over 2 months as the safest investment to make in a volatile currency market.

The British pound (£.8908) has continued to weaken against the euro also.  The Bank of England is considering another interest rate reduction which would take the rate to 1%.  This would be the lowest Bank of England rate in its history.  The pound also weakened against the South Korean won in addition to the Canadian currency. 

Another notable currency pair that has seen a lot of volatility is the Australian/yen.  The Australian dollar has declined 40% against the yen since the first week of August.  The Brazilian real has seen a 45% weakening against the yen during the same time period.  Against the dollar, the yen has risen 20% this year while the number is 35% for the euro/yen and 43% for the won/yen. 

China has declared it will be able to handle its economic crisis without assistance.  The country is focusing on strengthening its domestic economy to compensate for lost exports. 

In the next week, the US Federal Reserve is expected to reduce interest rates yet again which will leave it close to zero.  This could encourage investors to continue accepting higher risk which will lead to a continued weakening of the US dollar.  When interest rates are so low, investors often turn away from investments funded with dollars.  Other currencies see the weakening dollar as bringing some relief to a depressed import/export market. 

As the bad news economic litany continues, there is plenty of speculation going on concerning the future of currency prices.  But until the world economies find their recession bottoms, there is really no certainty built into the markets yet.

 

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