Europe just starting to feel the pain already much in evidence in the UK and US

Foreign Exchange Outlook : The market is flirting with a return to risk appetite that is most visible in price rises in some commodities (copper, oil) as well as equities. At the same time, traders are girding their loins against really bad economic data, of which Friday’s payrolls is the most important. Market News reports the median number in its survey is a drop of 490,000, with a forecast range of 450,00 to 567,000. This comes after 533,000 job losses in November and 320,000 in October.

Offsetting the economic gloom is a rising sense that a can-do Obama administration really can create growth in some areas and that the reduction in fear is itself a pro-growth factor. Market News reminds us that when Reagan came into office in 1981, the US Dollar Exchange Rate was just coming up off a crisis level of 1.7250 against the DM. The previous Oct (1980), Fed funds had reached 20%--remember Mr. Volcker? While the US Dollar was already rising off the lows of the 1980 year when Reagan took office, he gets credit for the can-do attitude, even if Reaganomics had very little valid underpinning. Persisting today is a near-worship of Reagan by some but even those who thought the supply-side ideas were dumb have to admit that sheer attitude and the force of Reagan’s personality and charm were effective in restoring confidence. (He could also construct a whole sentence, too.)

Foreign Exchange Analysts point out that it’s impossible to untangle the psychological factors and the "real" economic and market forces at work. We say three things are critical. First is Obama convincing foot-draggers in Congress to shut up and go along with his plans. He will make a major speech tomorrow on recovery initiatives.

The second is greater confidence in the institutional infrastructure. The Fed's US mortgages market actions are already seen as a huge success two days into the initiative, if not grabbing headlines in the financial press just yet. Now we need success like this on every front, including the SEC. Numerous articles are appearing reviewing what happened, who or what is at fault, and how to prevent it next time. A lingering worry is that the guys who got us into the mess (Geithner, for example) are still the guys in charge of getting us out. We need to see a change in mind-set and not just personnel.

The third thing is perception of "how much is enough." This is one of the lessons every junior banker learns in credit school - is the borrower asking for the optimum amount of money to make the new business plan workable?

Right now it looks like the Obama plans will encompass $1-2 trillion, with $775 in stimulus spending and $300 billion in tax cuts (so far), on top of the $700 billion in TARP money plus whatever the Fed is doing.

Is that enough?

If the markets perceive that it is, they will open their wallets. A ton of money is sitting on the sidelines. In particular, corporations are stuffed with cash and refusing to invest in capital spending. So we not only need to see corporate bonds become acceptable paper again, we need to see corporations spend some of their own money.

Nothing spells confidence like capital spending.

We say that tax and other incentives to boost capital spending (as opposed to consumer spending) are the key to the success of the Obama plans. If tomorrow we start getting confidence in this aspect of the recovery initiatives, the payrolls number the next day will lose its sting. Yes, this means we think the psychological factor (returning confidence and hope) can outweigh bad data. The psychological factors are forward looking while the data is, by definition, backward-looking. Markets like to anticipate, and none so more than the Foreign Exchange market. With Europe just starting to feel the pain already much in evidence in the UK and US, hope is more likely to arise on this side of the Atlantic. So far Asians seem to be willing to believe in the Fed, and let’s face it, Asians are the ones with the money these days. Meanwhile, Middle East sovereign wealth funds and other official and semi-official asset managers are licking their wounds and watching the oil price fall—but they will be back someday, if only because of the dearth of safe investment opportunities in their own region.

Now let’s look at the calendar. Jan 19 is a national holiday in the US and the inauguration is the next day (not a holiday). Analysts say mid-Feb is the earliest we can expect Obama initiatives to hit the streets, but we guess the can-do effect will hit before then. This could be wildly US Dollar - favorable.

We just need this dratted correction to end first.

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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