There are a number of fundamentals which indicate to me that the dollar is set to depreciate in a trend, at least over the next few months. Also, the S&P is making a crucial technical test which indicates that the rally which began with Bernanke’s admission of electronic printing is still intact.
The most obvious fundamental is the Fed’s continued use of the “extended period language,” which has now been in use for about a year. Even more importantly, the likelihood of the Fed making a move this year, or even signaling that it will, is virtually nil.
Inflation will be well below the area that the Central Bank wishes it to be. Core PCE, the Fed’s preferred gauge of inflation, looks to be in a range of between 0.9% and 1.2% for the year, well below the 1.8% to 2.0% it wants.
Unemployment is likely to remain high this year, and will probably finish no lower than 9.5% or so. The administration itself admitted this yesterday with its curious statement (actually a joint statement issued by Treasury Secretary Tim Geither, White House budget director Peter Orszag and Christina Romer, chairman of the Council of Economic Advisers) which said that unemployment is expected to “remain elevated for an extended period.”
Reading between the lines of this statement indicates to me that Mr. Obama now sees the democrats as being in extreme distress in terms of the mid-term elections this November, and probably views his Presidency in peril for the 2012 re-election as well. People vote their wallets and as long as they feel light, incumbents will remain at risk.
The quickest solution to the unemployment problem is to import as many jobs as possible, which is best accomplished by depreciating the currency. Mr. Obama appointed a Fed Chairman who no doubt shares this view since he’s done everything in his power, including going on T.V. to admit printing dollars, to weaken the dollar.
The President will also be appointing notable dove Janet Yellin to fill the vice-Chairman’s seat being vacated by long-time Fed Donald Kohn, and he’ll have the opportunity to appoint 2 more Feds which means that the FOMC will be well-stocked to resist the more hawkish views of the regional Fed Bank presidents like Thomas Honig.
Additionally, we now have congress getting serious about the need for yuan appreciation. Five senators including Charles Schumer of New York and Lindsey Graham of South Carolina introduced legislation yesterday to make it easier for the U.S. to declare currency misalignments and take corrective action. Simply put, Obama’s goal of doubling U.S. exports in five years depends on his ability to get China to raise the value of its currency. And as Economist Paul Krugman mentioned recently, the dollar will depreciate against major currencies such as the euro when this occurs.
Basically what we have is the President, the Congress and the Federal Reserve all on board publically that their intention is to weaken the dollar going forward.
Do you want to bet against this?
As far as the S&P 500 is concerned, it recently made a double top at the Jan. 19th high. Yesterday, it broke through that resistance. What we could see over the next few days is a test of this former resistance as support, which I believe will be found. And as stocks gain, the dollar will trend lower.
Did I mention that the Greek debt crisis is over for now?
The euro has already started to gain against most major currencies after European finance ministers worked out a strategy for emergency loans to and Standard & Poor’s affirmed the nation’s credit ratings. According to Bloomberg, global investors bought more euro-region equities than they sold for the last two weeks after having been net sellers the preceding 23 weeks on concerns a default in Greece would spread to other euro-region members including Spain and Portugal.
Rising equities will pressure the euro higher.
GDP in the first quarter of 2010 will be lower than last quarter, but that’s a good thing according to an article written by Kathleen Madigan in The Wall Street Journal. The expected number is between 2% and 2.5% vs. the 5.7% recently seen.
Q4 2009 GDP was driven to a large degree by an inventory rebuild (3.88 percentage points of the 5.7% jump in GDP last quarter), something that doesn’t look to be repeated now. But that’s a good thing because the numbers will show that demand is leading the way, and that will be interpreted as evidence of sustained growth.
Core sales — a measure that goes directly into GDP calculations and which exclude autos, building materials, and gasoline — jumped 0.9%. The uptrend in core sales suggests real consumer spending is growing close to 2.5% this quarter, better than the 2% rate he was expecting before the February retail data were released, she writes.
The February data indicates that consumers are back. And even though the headline number will be lower, the number will look better because final demand creates a more sustainable recovery due to increased spending that will start the cycle of more orders, production and hiring, leading to more spending.
China-There’s Nothing To Fear But Fear itself
Nobel prize-winning economist and New York Times columnist Paul Krugman says that the U.S. has no reason to fear China.
“What you have to ask is, what would happen if China tried to sell a large share of its U.S. assets? Would interest rates soar? Short-term U.S. interest rates wouldn’t change: they’re being kept near zero by the Fed, which won’t raise rates until the unemployment rate comes down. Long-term rates might rise slightly, but they’re mainly determined by market expectations of future short-term rates. Also, the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.
It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around. So we have no reason to fear China.”
It all comes back to that famous quote by economist John Maynard Keynes: “Owe your banker £1,000 and you are at his mercy; owe him £1 million and the position is reversed.”
China’s position as the largest foreign holder of U.S. debt means that if they were to dump their holdings, their price will necessarily decline, thus imposing a potentially large capital loss on themselves.
The fear is that if the Chinese stop buying our bonds it will raise interest rates on Treasury securities. That’s probably why the Treasury never presses the Chinese too hard on this issue. However, economist Gary Burtless of the Brookings Institution believes that the increase in U.S. growth resulting from a decline in the trade deficit, which subtracts from GDP, would more than compensate for the increase in interest rates.
According to former Treasury Department economist Bruce Bartiett, “As long as the U.S. national debt is entirely denominated in dollars, there is no risk that we will run into the sort of financial crisis that small countries often run into. What gets them into trouble isn’t the debt per se, but an inability to acquire sufficient foreign exchange with their own currency to service it. While the U.S. Treasury has never issued bonds denominated in foreign currencies, it is conceivable that it could be forced to do so if the dollar falls sharply and foreign demand for U.S. bonds wanes. That will be the point at which our debt problem becomes more than theoretical and we are really on the road to national bankruptcy.”
After a rally which has lasted since Fed Chairman Bernanke announced on the 60 Minutes TV program that the Fed was “electronically” printing dollars on March 15, 2009, the S&P 500 has made a double top which may indicate a reversal. That doesn’t mean I’m ready to short stocks (and get long the dollar) just yet, but it does mean I’m being careful.
Although my style of trading is more fundamentally based in that I mainly use technical price points for entries and exits, I think it’s important to recognize chart formations that are obvious and likely to catch the eye of even a casual observer. This formation definitely falls into that category.
What’s also interesting is where the double top was made.
I use several non-standard Fibonacci levels which I’ve found to be accurate and useful. For example, most people who use fibs on their charts have the 50% retracement line, which actually is not in the standard 23.6, 38.2 etc. fib sequence. I use it also, primarily because everyone else does. Fib levels themselves are separated by Fibonacci’s “golden ratio” of 1.618. To go up in a sequence, you multiply by the golden ratio and to go down, you divide. If you multiply the 50% retracement level by 1.618, you get 80.9. In other words, 80.9 is the next number in a Fibonacci sequence that begins with 50 and I use this level on my charts.
I set up a fib sequence that measured the fall of the S&P from the time Lehman collapsed until it hit bottom in March 2009, and I’ve been measuring the retracement of this decline expecting that at some point in the near future to see the entire decline retraced. But what’s interesting is that the 80.9 fib level is exactly where the S&P has made its double top.
And that has me a bit nervous about where stocks could be headed to from here.
In the post-crash economy, what we’re left with is an ever-widening divide between the haves and the have-nots. The haves (big banks, Wall Street firms and corporations) are doing quite well thanks to the Fed’s extraordinary interventions. The banks are making more money than ever thanks to the steep yield curve, Wall Street firms are earning money hand over fist, and corporations can once again borrow in the capital markets at very low rates. A new study done by economists Allen Sinai and Paul Edelstein has estimated that the Fed’s actions boosted GDP growth by 1.9 percentage points in 2009 and would add 3.3 points this year.
While that sounds great (and certainly things would have been much worse absent the Fed’s actions), the facts are that little if any of this stimulus has trickled down to the general population as of yet. Why would I say this? Well, aside from the dismal unemployment figures, there’s another simple metric I use to gauge what’s happening in the real economy-gasoline usage.
One thing is for certain; Americans love their cars. They love to drive and they love the freedom that driving affords. But if you look at the weekly Oil Inventory reports, you’ll see that gasoline usage is still down from last year’s seriously depressed levels. Also, as reported on Thursday, January’s Trade Gap unexpectedly narrowed by 6.6% to $37.3 billion because the demand for foreign oil and automobiles dropped. The U.S. imported just 245 million barrels of crude oil in January, the fewest since February 1999. My point here is that Americans would be burning more gasoline if they truly were doing better. The fact that they aren’t speaks volumes.
It all comes down to the jobs which haven’t re-appeared despite all that’s been done. I’m also not so sure that demand for workers is going to pick to any serious degree either, and the reason I say that is because Productivity (the measure of output per worker hour) keeps going up. And while that’s good for corporate profits because the cost of production is low, it doesn’t bode well for jobs. After all, if a firm can produce more goods and services with fewer workers, why would they hire and bring the cost of production up? The only way they will is if they believe that final demand will increase to the point where production can’t meet it.
So, while it’s likely that we’ve seen the last of the big job declines, there’s little reason to believe that hiring will expand strongly going forward. It looks like what we’re left with is Nouriel Roubini’s vision of an economy that has come out of a recession but for most people, still feels like one.
Setting up an advantageous reward to risk ratio is an overlooked aspect in trading, but one whose importance is critical in establishing yourself as a successful trader.
Typical retail traders will often look at their “winning percentage” as an important metric. Most traders would dearly love to be able to say they can pick 70% or 80% winners. After all, it seems logical to say that if you win more than you lose, you should be profitable. Most will also say that they’d be happy to break out even in terms of money won or lost if they’re running 50% winners.
The facts are, however, that few if any traders can maintain a 70% to 80% winning percentage over time. But don’t let that discourage you because I’ll show you that there’s a way to be profitable by winning just 33% of the trades you enter (or even just 25%)!
It all comes down to entering trades where the risk is greater than the reward. The lower the winning percentage you can make a profit with, the greater the odds are that over time, you’ll be profitable. In other words, it’s the trader with the lowest profitable winning percentage that truly has the advantage. Let’s take a look at the numbers.
If you risk 30 pips on a trade that can return 90, you’ve set up a 3:1 reward to risk ratio. If you lose 2 of these trades and win just 1, you’ll still be 30 pips ahead of where you started because while you’ve lost 60 pips on the 2 losers, you’ve gained 90 on the 1 winner. In other words, a winning percentage of just 33% has got you nicely ahead of the game!
On the other hand, let’s say you set up a trade where you risk 30 pips to win just 20 which, believe it or not, is how a lot of people trade in reality even if they don’t set it up that way in the first place (how many times have you traded with a 25 or 30 pip stop and then was happy with the profit after 15?). In this case, you have a 2:3 reward to risk ratio which in this example means that even if you win 3 out of your next 5 trades (60%), you’ll still be just breaking even!
The key to being able to do this is to do what every trader knows-in a long trade for example, you want to buy low and sell high. Buying low means two things. First, you want to buy at a price as close to possible to where you’ve recently seen buyers come into the market because it’s essential that, for a long trade, that you not allow yourself to get stopped out where buyers have recently been. Second, the point at which you buy must be far enough away from a logical target so as to set up an advantageous reward to risk ratio. In other words, you have to set a target at a price where you’ve seen buyers recently go to so that you’ll have a chance to “sell high” after you’ve “bought low.”
In the second part of this article, I’ll show you some chart examples of what I mean, and I’ll show you how to make a judgment as to where logical entries and exits are based on recent price movement.
Before I begin, allow me to invite you to a special event on Sunday, March 7 at 5:30 pm EST. At that time, I will be holding a free session of my online trade room for all who might wish to attend. Sundays are usually fun (and profitable) as we go over what’s happening in the markets and look to take advantage of the opening gap in prices. All you need do to attend is click here to reserve your seat.
German officials are apparently in no hurry whatsoever to cobble up an aid package to fellow EU member Greece. Both political and economic considerations back their thinking, but the bottom line is that Germany has probably calculated that with or without a common currency of even an EU, Germany will do just fine.
From a political viewpoint, bailing out profligate spenders is bound to raise the level of bile among German voters. And this is made even worse by the fact that Greece basically falsified their financial records and participated in currency swaps (with the aid of Goldman Sachs and other investment banks) in order to hide the real size of its deficit.
From an economic viewpoint, Greece is just a tiny country with just $345 billion of GDP. Even if it were to default, it would make no difference to the global economy except in the sense that investors will grow concerned about the prospects for other EU members like Spain, Portugal, Italy and Ireland.
Germany is actually reaping a huge benefit from the euro’s decline over the past several months. As the world’s 3rd largest exporter, its cars, high-tech machines, software and chemicals are becoming even more competitive as the global economy heats up. And just as importantly, German firms will of course reap the benefits of added profits upon repatriation of profits made overseas.
Germany isn’t without problems of its own either. The economy is still growing anemically and their own debt-to-GDP ratio is now running over 7%, which means they need to grow quickly themselves in order to avoid spiraling into an even worse situation.
Meanwhile, the EU keeps trying to talk a good game in terms of the plans they’re “developing” but the fact of the matter is that after even all this time, nothing concrete seems to be forthcoming. All we have so far are rumors involving German and French state-owned banks along with ECB president Trichet’s apparent fear and disdain for seeing Greece turn to the IMF, which they are threatening to do.
The fact that Greece was able to successfully sell about $10 billion in new bonds on Thursday doesn’t really help all that much, because they are paying a very high (6.3%) on the debt. Yes, investors bought them up, but all that does is just allow for the issuance of new Credit Default Swaps (CDS) which Hedge Funds and other sophisticated investors game. CDS are where the real profits are made anyway in this market.
Still, Germany may relent and actually come up with a package of loans and/or loan guarantees. But if that happens, the euro will snap back into the upper 1.40’s in a matter of weeks as traders reverse their bets and as the Federal Reserve keeps hammering home the point that interest rates will be staying low for an “extended period.”
But if Germany does pull the plug on the cradle of democracy, the fall of the euro is all but assured.
Before I begin, allow me to invite you to a special event on Sunday, March 7 at 5:30 pm EST. At that time, I will be holding a free session of my online trade room for all who might wish to attend. Sundays are usually fun (and profitable) as we go over what’s happening in the markets and look to take advantage of the opening gap in prices. All you need do to attend is click here to reserve your seat.
The recent plunge in the euro was driven by some of the biggest Hedge Funds, according to an article published in the Wall Street Journal.
Apparently, giants like SAC Capital Advisors and Soros Fund Management, run by Steve Cohen and George Soros respectively, actually got together in N.Y. recently to map strategy in the wake of the Greek debt crisis. According to the article, an SAC manager, Aaron Cowen pitched the group on the bearish bet, saying he viewed all possible outcomes relating to the Greek debt crisis as negative for the euro.
Of course, big traders like George Soros, whose fund manages around $27 billion, have an advantage that we retailers can only dream of: the power of his word. Last week he warned publicly that if the European Union doesn’t fix its finances, “the euro may fall apart.”
Of course, the corollary also holds true. When a solution to the problem is announced, as is expected later this week or early next week, we’re likely to see the euro bounce back strongly as these giant traders cover short positions and reverse their bets.
Greece has about 20 billion euros coming due in April and May, and it has to issue additional debt in order to roll it over. At this point, it’s likely that a new offering is being delayed as EU officials spar over the extent to which Greece will need to implement additional austerity measures. Officials basically have egg all over their face after being snookered by phony Greek data regarding its true debt situation, and they’re likely to demand their pound of flesh in exchange for any guarantees.
The latest thinking is that state-owned banks in Germany and France will buy and/or guarantee this new round of debt, but that won’t happen until Athens can assure the EU that it can reduce its deficit from around 12% of GDP to 4% this fiscal year.
Germany itself has a very good reason to let Greece twist in the wind a while longer, because a weaker euro is an enormous help to the world’s third-largest exporter. That only works to a point however, because a lack of confidence in the common currency will have far more damaging effects if the rout becomes too large too fast.
Meanwhile, the conflicting reports regarding a bail-out for Greece led by Germany and France to the tune of€30 billion ($41 billion) began to take shape last week .
Greek officials said they expected to seal a deal by march 5, when Greek Prime Minister George Papandreou meets in Berlin with German Chancellor Angela Merkel, but senior German officials insisted a bailout wasn’t imminent.
“There is definitely no such plan,” said Ulrich Wilhelm, spokesman for German Chancellor Angela Merkel.
You can bet that isn’t true. Greece isn’t going anywhere and neither is the euro.
Before I begin, allow me to invite you to a special event on Sunday, March 7 at 5:30 pm EST. At that time, I will be holding a free session of my online trade room for all who might wish to attend. Sundays are usually fun (and profitable) as we go over what’s happening in the markets and look to take advantage of the opening gap in prices.
All you need do to attend is send an email to mcarniol@fxinstructor.com. I’ll put you on my invite list and send the log in instructions that Sunday morning.
Fed Chairman Ben Bernanke will reiterate in testimony to Congress on Wednesday and Thursday that economic conditions “are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
I would expect to see the dollar weaken against the PEAK currencies (pound, euro, A$ and K$) in anticipation, but whether the stronger dollar trend can be bucked is another matter altogether.
The risk of sovereign default(s) is certainly still present and seeing one or more happen would not be surprising to many economists (Greece has a higher debt-to-GDP ratio than Russia and Asian nations had during the last round of sovereign defaults in the 1990’s). Harvard economics professor and former chief economist at the IMF Kenneth Rogoff said on Monday that sovereign defaults could lead to slower global growth although he doesn’t see another recession on the horizon. Bur he also added that China is at risk of a financial crisis due to the extraordinary amount of new debt that’s been created as a result of the government’s stimulus programs.
Former Fed Chairman Allen Greenspan said on Tuesday that the world economy has undergone “by far the greatest financial crisis globally ever.” He also called the recovery “extremely unbalanced” as high income consumers and large businesses benefit from a rebound in stock prices.
This “recovery” has been engineered by the Fed’s enormous liquidity injections, as it “electronically” printed money to lend or buy securities that were (and are) nearly completely illiquid.
The banks remain paralyzed with enormous losses which still remain on their books, and the amount of credit extended in the economy declined by the most in history during 2009. The large commercial lenders are holding over $1 trillion in reserve at the Fed-money that is not being circulated and therefore is creating no velocity.
Commercial real estate is basically a disaster waiting to happen, since nearly every property bought since 2005 is “underwater” on its mortgage. And as these loans mature over the next several years, owners who cannot pony up enough cash to get new financing will be sending their keys back to the bank.
The risks for market participants going forward are likely to intensify in the second half of 2010 as global GDP slows from robust levels. For currency traders, that will present another opportunity to long the dollar against the PEAK. Actually, the dollar is very likely to continue strengthening going forward no matter which way the U.S. economy goes.
If employment and other data surprise to the upside, traders will bet that the Fed is moving ever closer to real tightening (even though it won’t happen in 2010). And anything that causes investors to turn risk averse will cause them to move reflexively into dollars and treasuries, as we’ve seen repeatedly over the last several years. The only scenario in which that wouldn’t happen is if the risk of default by the U.S. increases, something which is so far-fetched that not even Nouriel Roubini would mention it.
Thursday’s 25 basis point increase in the Discount Rate, rate charged to banks for direct loans, was the Central Bank’s latest step towards normalizing policy, a process that will likely take several years. And while the move by itself does not signal that a change is imminent in the Overnight Rate (the Fed Funds Rate), it certainly will stir speculation that the Fed is moving closer changing its language regarding the need for “exceptionally low” levels for an “extended period.”
Today’s move widens the rate’s spread over the top range for the benchmark federal funds rate to 50 basis points (0.5 percentage point), half the normal 100 basis point difference.
It’s All About “About”
Fed watchers are likely to note a subtle shift in the Fed’s tone, because although the accompanying statement did point out that today’s move did “not signal any change in the outlook for the economy or for monetary policy,” it also mentioned that the outlook for policy remains “about as it was at the January meeting of the Federal Open Market Committee.”
“About as it was,” to my way of thinking, is different than saying “as it was.” It implies that improvement has been made since the last meeting and that conditions going forward will allow further moves to unwind the extraordinary measures taken in response to the credit crisis. In other words, it’s another step towards normalizing policy and doing business as usual.
In addition to raising the rate, the term for Discount Window loans was reduced to overnight. The Central Bank had increased the term to 90 days and reduced it 28 days on January 14.
In reaction, S&P futures were lower by just over 1% by 10 pm EST and the dollar was gaining on the euro, pound A$ and K$. USD/JPY, after rising initially, started to head lower as what usually happens when stocks retreat.
At this point, it’s safe to say that in the absence of aggressively dovish comments from Fed officials, the short dollar trend that began in March 2009 is, for all intents and purposes, officially over.
According to Goldman Sachs economist Ed McKelvey “we don’t expect or advocate rate hikes anytime soon–not in 2010 and probably not in 2011 either.”
Aside from an actual increase in the Fed Funds rate, the real number that market participants should be looking at is the interest the Fed is paying the large commercial banks to keep reserves on deposit at the Federal Reserve banks, currently 0.25%.
Depository institutions are currently holding over $1.16 trillion of reserves at the Federal Reserve banks. That compares with about $14 billion to $17 billion that banks held there merely as a reserve requirement prior to the escalation of the credit crisis in 2008.
These reserves were created when the Fed “electronically” printed dollars in order to buy assts like Mortgage Backed Securities (MBS) from the banks. The market for these securities virtually shut down in the wake of the Lehman Bros. collapse back in September of 2008 and remains almost non-existent. Currently, the Fed is holding just over $1.9 trillion of securities of which over $971 billion are MBS.
This amount of reserves being held represents about $10 trillion in potential lending that isn’t being put into the broader economy now, but it also represents a potentially huge inflationary force if the commercial banks were to resume normal lending armed with this enormous cache of reserves.
In his written testimony released last Wednesday, Fed Chairman Bernanke said that the interest on reserves tool stands a good chance of supplanting the overnight fed funds rate as the central bank’s focus in a coming tightening cycle. Instead of targeting the funds rate–currently between 0.00% and 0.25%–the Fed would raise the interest paid on reserves, thereby creating an incentive for the banks to keep a level of reserves on deposit and earning a risk-free rate of interest. Bernanke also said the Fed may set targets for bank reserve levels as well, in another departure from the current regime.
A logical question at this goes as follows: if the Fed and the government want the banks to be lending more, then why is the Fed paying interest on those reserves at this time. In other words, why is the Fed creating an incentive for the banks to hold those reserves at the Federal Reserve banks when what they want is for the banks to circulate these funds into the economy.
The answer, in part, is because the Fed bought these securities in the absence of a market for them. What that means is that no one-not the Fed, the banks, or anyone else-knows exactly what they’re worth. And if the Fed presumably wants to sell those assets back to their original owners, then they money to buy them to have to actually be there. Still, the Fed bought these securities in order to re-liquefy these otherwise bankrupt financial institutions with the idea that at some point, normal lending would resume.
Another reason for the Fed to create this incentive is because in reality, the banks are still holding an enormous amount of losses on their books although at this time, due to the changes in accounting rules, the banks are not required to write them all down at this point. These losses are projected to continue for years to come.
For example, RealtyTrac estimates that another 3 million homes will fall into foreclosure in 2010. If the average value of a mortgage is $240,000, and mortgagors typically lose about half that when a foreclosure occurs, it means that about another $360 billion of losses will happen this year on top of all the previous hundreds of billions of dollars which have already been lost.
What this means for the dollar going forward is that absent the type of crisis we’ve seen recently, it’s likely that the dollar will depreciate. That’s a big “if” though at this time because Greece in not alone; there are risks that countries like Spain, Portugal, Ttaly and perhaps Ireland will also require a level of assistance and/or auterity measures to bring their deficits in line. There’s even the risk, although remote, that Britain itself could come under pressure.
In that case, the one sure currency bet is for dollar appreciation because as nearly always happens, when the market panics it does so by seeking out the safety of greenbacks and Treasuries.
Federal Reserve Chairman Ben Bernanke released the transcript of his congressional testimony Wednesday morning in lieu of actually appearing due to the record snowfall which hit the region.
While Bernanke provided more detail on the exit process, he also made clear that he does not expect to tighten policy in any meaningful way anytime soon. He repeated the FOMC mantra that the economy needs “exceptionally low level of the federal funds rate for an extended period.” He set out the Fed’s current thinking on how policy will eventually be tightened, “at the appropriate time …” None of this will happen soon, though, and the likely near-term hike in the discount rate, he was careful to note, “should not be interpreted” as a policy signal.
The bottom line is that the Fed will not materially tighten policy in 2010. More than likely, the funds rate target will be unchanged at year end, there will be no hike in interest paid on reserves and the Fed will have a balance sheet that will still be north of $2 trillion.
Aside from considerations relating to inflation and unemployment, there’s another reason for the Fed to keep borrowing costs as low as possible. I offer the following analysis written by Kelly Evans in The Wall Street Journal. She writes:
The Commerce Department reported Wednesday that the U.S. trade deficit widened in December to $40.2 billion, compared with $36.4 billion in November.
The widening reflects faster growth in imports than exports at year-end, an unwelcome side effect of the U.S. economic recovery. It also is a reminder that export-led growth, which nations are pursuing as a path out of recession, is easier said than done.
President Obama has called for a doubling of U.S. exports over the next five years to help narrow the trade deficit and spur economic growth. The quickest way of doing so is a weaker dollar, which makes U.S. goods and services cheaper in the global market.
But lately, the dollar is moving in the other direction. Worries over the fiscal health of Greece and other nations have dogged the rival euro currency, which hit an eight-month low on Tuesday before closing a few cents higher.
Goldman Sachs economist Sven Jari Stehn calculates that even with above-consensus global growth of 4.5% over the next five years, the dollar still would need to depreciate in inflation-adjusted terms by about 30% for U.S. exports to double to about $3.1 trillion.
If instead the strengthening continues, “it would wipe out all the other bits and pieces [the president] is putting together to encourage exports,” said Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management.
And while investors focus on whether the big European nations will come to their smaller neighbors’ rescue, Mr. Johnson points out that Germany, the world’s biggest exporter until China surpassed it last year, is reaping the benefits to its own exports that come from a weaker currency.
European nations mightn’t be in as much of a hurry as investors assume to halt their currency’s downward slide. That could make an export-led U.S. recovery its own Greek myth.
To that, I would like to add that it seems as if what’s happening now is always what happens in times when the global economy slows-countries pursue a “beggar thy neighbor” policy of currency depreciation in order to boost their exports. Implicit in Mr. Obama’s stated goal of increasing exports is exactly that; a weaker dollar.
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