Foreign Exchange Outlook

Foreign Exchange Outlook : The US dollar has two big black clouds hanging over it. First is the election and then there is payrolls.

Today the US election is everything. If it’s an Obama landslide and/or if there is no dispute over the fairness of the counts, that would remove a black cloud hanging over the dollar from the last election. We also want to hear right away - this week - the name of the incoming Treasury Secretary and some broad outlines of the financial plan. A $1 trillion budget deficit is very big dollar exchange rate negative. Assurances of an effort to balance the budget would go a long way, even if they are not really credible.

Once the election is over, attention will turn immediately to ADP’s forecast tomorrow of the payrolls numbers on Friday. Market News gets a survey average result of a drop of 200,000 in Oct, but estimates range from –85,000 to –230,000. The jobless rate, the worst fiction in the data pantheon, will probably rise from 6.1% in Sept to 6.3% but perhaps as much as 6.4%. Realistically, it’s probably 8-10% already if the count were done properly.

There is a consensus of opinion from Foreign Exchange commentators everywhere on the US election. Calyon wrote "We think a decisive win in the Senate for the Democrats as well a win for Senator Obama, as the polls indicate, would boost risk appetite as the risk of political paralysis will be reduced going forward.” Separately, UBS says the focus will shift to the "transition between administrations and how the president-elect handles the growing budget deficit."

Let’s say McCain wins and payrolls show a gigantic drop of 230,000 or more. The US dollar exchange rate would be toast by noon on Friday - to the recent high of 1.3298 - on the prospect of more shooting wars, endless deficits, and probably a disputed vote count. Can an Obama win offset really bad payrolls data? Yes, maybe. If Obama wins, the US dollar has a real chance of proceeding on its upward trend on "fundamentals" other than the safe-haven flow from deleveraging, or "forced liquidation," as Jimmy Rogers puts it. In other words, the US dollar would get a positive reason to be firm rather than a negative one. As we all know from the Economist’s poll and other surveys, the world would vote for Obama if it could. This is just a funny tidbit except in the context of confidence in US management of the economy and thus potential capital inflows.

We could name a third black cloud - Crude Oil.

With a new embrace of risk and stock markets generally unwilling to accept the recession/deflation/Depression scenario, it’s possible that oil stops falling. It’s hard to say how big a factor this might be. To sell dollars in a knee-jerk “because” oil is rising sounds stupid, but some folks do it. At the least it can have an effect for a few days. A bigger effect is on the US current account deficit (remember that?). We need oil prices to fall to avoid another round of twin deficit talk.

Even with falling oil prices, the current account deficit has structural characteristics that make it slow to fall. And with the appetite for a doubling of long-term debt unknown (hence talk of revising a 3-year note to bridge maturities), the US could actually face funding difficulties. The Treasury capital flow report has not been dollar exchange rate friendly lately, although it’s distorted by emergency cash–raising, revulsion from Freddie/Fannie, and the like. But in the Big Picture, the US needs to show progress on the current account if funding needs are doubling. It’s not clear how that can be accomplished. Again, we have to say that longer-term, it’s all too easy to make the case against the dollar. But in the meanwhile, keep the faith. Things are worse elsewhere.

A big bad Event can easily restore the US dollars fortunes, and if we have learned anything over the past year, it is to expect surprises

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Barbara Rockefeller
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