Outlook - Foreign Exchange Traders Buying Euros

We get the University of Michigan preliminary index of consumer sentiment this morning, probably a drop to a 28-year low of 55.5 in July from 56.4 in June, according to the Bloomberg survey. Well, if a bad number is expected and priced in, we may get no reaction on the actual release—and if it’s a better number, maybe even a small relief rally. Anyone who is surprised by grim consumer confidence hasn’t been paying attention. Today we also get the trade deficit for May, probably a widening to $62.7 billion from $60.9 billion seen in April on higher energy prices.

Next week we will get some bad news from Europe (industrial production, ZEW) and it remains to be seen whether it has been priced in. On the whole we are unaccustomed to bad economic news from Europe so it tends not to be priced in. In addition, panic and hysteria over conditions in the US (Lehman, Freddie and Fannie, gas prices, etc.) may settle down after a calming summer weekend without massive thunderstorms for once. (Somebody somewhere has done a correlation study on the amount of electricity in the air from lightning storms to moves in the S&P…).

All of this adds up to a potential US Dollar rebound next week. Foreign Exchange Traders can’t hang on to high levels of adrenaline for long periods—it’s just too tiring. And there are plenty of coins lying around on the street to pick up. Pimco is picking up shares of Freddie and Fannie, as noted above. GE had no trouble finding a buyer for its household appliance unit and now its Japanese consumer finance unit. Citibank is selling its German retail business. Europeans are buying a big US beer company, and the NY Times carried a fascinating table on US real estate purchases by foreigners, mostly the Middle East but followed closely by Germans. The Germans are so at-home with US real estate that they just sold the Chrysler building.

You know the bottom is in sight when bargain-hunters come out of their lairs. Some bargain-hunters are too early and get their hands chopped off, like Citgo’s $1 billion buy-in to Bear Stearns, but never mind—vultures are useful birds (and quite beautiful in flight). We can’t say if perception of bargain-hunting will start helping the Buying US Dollars, and certainly not that it will help as early as next week, but let’s learn a lesson from history—in the 1990’s, the US dollar recovery was accompanied by a big rise in foreign direct investment. A lot of FDI has been diverted to China and India in recent years, hence all the wailing and gnashing of teeth over hot money, but let’s face it, money is simply safer in the US than in emerging markets, and when the rate of return looks on a par with Chinese returns, the US can be very competitive in that race.

Realistically, though, not many are looking at the Big Picture, at least not yet, and next week we get a ton of potentially bad data on everything from inflation (both PPI and CPI), housing starts, the capital flow report from the Treasury, and the earnings reports of major financial institutions. Bad numbers on any or all of these fronts will feed the dollar downtrend.
We are a little surprised that sentiment toward the dollar seems to hinge to a certain extent on the fate of Freddie and Fannie. All the commentary from Asia, and especially Japan, mentions the potential government bail-out. Evidently these traders want the US government to state unambiguously that Freddie and Fannie are too big to fail and of course they will be “guaranteed” as well as “sponsored.” We say experience teaches us that the US government, having made a hash out of Freddie and Fannie for so many years, is hardly likely to act swiftly and decisively now. Paulson and Bernanke have the moxie to step in, though, so there is some small hope on this matter. The betting is that next week Freddie and Fannie get rescued one way or the other, without trashing their private stock issuer status, while Lehman may fail and the Bernanke-Paulson team will let Lehman fail.

From a political philosophy point of view, it’s hard to know where Bush and his advisors will stand on Freddie and Fannie—and make no mistake, the resolution is a deeply political one. The Bushies no doubt like the idea of a government agency having a double identity as a private firm with its own stock listing. They don’t like government being in business—too pinko. But they may be willing to throw them under the bus, the cliché of the moment, to prove that government doesn’t belong in business and always does make a hash of it. We say that to abandon businesses worth over $5 trillion to make a political point is the eight of folly, but consider these quality of the people we are talking about. In the end, we imagine Paulson earnestly trying to convince the Bushies that failure is failure and that’s what will be remembered, along with Iraq, gas prices and the trashed dollar, not the political principle. The Bushies could argue that this is their Reagan moment, likening the crash of Freddie and Fannie to Reagan’s destruction of the air traffic controllers union.

We like to bet on common sense prevailing and Congress being unwilling to let Bush have his way with something as important as Freddie and Fannie. It could pass emergency legislation authorizing a rise in the public debt to save them. That has its own fallout, of course. Either way, we won’t get a resolution today or probably even next week, and the dollar is likely to remain under pressure as a result. The Freddie/Fannie story is a lose-lose situation for the dollar. We also do not expect Israel to attack Iran, but that doesn’t mean the price of oil will fall back as cool heads prevail, assuming they do.

How severe will the pressure get? Pretty darn severe. We can easily see Foreign Exchange Traders Buying Euros over 1.60 and the yen under 105. Next week.

Bye for Now

Barbara Rockefeller