More trouble for the U.S. Dollar?

Recently, the FED has substantially cut rates in response to the growing recession fears that have spread into the minds of more academics and economists. Although the possibility of a recession is no small matter, the FED has seemingly ignored another major problem facing our economy and financial well-being.

Our US Dollar has resumed its downfall against other major world currencies, most importantly the Yen and Euro. After a mid-December rally, the USD has plunged to new lows again compared against both currencies. Despite a global credit crunch and recession worries in Asia and Europe, the FED typically acts most rapidly and decisively when problems arise. On this positive note, we can expect the other central banks to begin cutting rates sometime later in the year as a more reactionary measure instead of a combination between reaction and precaution. Asian growth is still expected to maintain, but interest rates have risen to unhealthy levels. Meanwhile, Europe seems a few months behind the US economy in the GDP cycle, so slower growth may not be realized until the late 3rd or early 4th quarter of this year.





One solution to the falling value of the Dollar the FED has yet to utilize is the mop up of excess money floating around throughout the economy. Unfortunately for the US central banking arm, excess liquidity has been necessary in a marketplace stricken with tightening credit standards and loan requirements. As the financial sector continues to right itself (with the help of much needed investment from the private sector and abroad), the FED may begin to start diminishing some of this exorbitant amount of dollars. Hence, less supply will help drive the USD's value back in the right direction.

Another big sell-off, but was it healthy?

As US economic growth wavered in Q1, coupled with a few big sell-offs in the equities markets, stocks steadfastly rebounded and repeatedly approached new record highs. Taking into account the vast amount of negative numbers regarding economic data, equity prices fearlessly drove higher, despite predictions by several top economists and market analysts that a recession was near. A key basis point of these bears centered around the inverted yield curve, a unique phenomenon which has been succeeded by a recession every time it develops.

Low and behold, several months and vastly higher heights later, another pair of significant sell-offs occurred. This time however, these bears are missing a significant piece to their pessimistic puzzle. Finally, after years of mismanagement by the FED and US Treasury Dept., the yield curve has begun to normalized. The inversion has reversed, as long-term treasury yields have overtaken the 90-day T-bill rates.



Another issue the bears seemed to dwell on regarded weakness in the US Dollar. Many argued that global equity markets would continue to prosper while US stocks would take a significant hit because of the weakness in profitability between exchanges in currency rates relating to asset levels and market capitalization. Unfortunately, these bears failed to realize the global impact and success of American companies abroad. Giants such as General Electric, United Technologies, and Boeing continue to impress and solidify market share across the globe. Therefore, these revenues made abroad will translate high relative to the USD, failing to impact corporation's balance sheets like pessimists believed they would. In addition, the Dollar has continued to climb against the Yen and made a good comeback against the Euro recently.

Therefore, don't expect a large correction over 5-6% anytime in the near future. The US economy is going strong and stock slumps are supposed to be caused by Bond yield inflation, not computer glitches. This is a natural cycle and valuations are still appealing in the equity markets.

Good numbers for the U.S. Economy

More good numbers came out today, suggesting a recession is not likely in the near term for the United States economy like some economists such as Paul Krugman and Barry Ritholz. Let's start with the bad numbers.

Pending Home Sales came in at -4.9% against projections of 0.4% increase due to spring buying habits. Part of this number may be due to the cold snaps felt throughout the early part of the spring. I wouldn't be surprised to see that number rally this month.

Now on to the good news. The ISM Manufacturing Index rose to 54.7%, a new 52-week high. With the good manufacturing numbers came a sharp decline in bond rates, a move that will help support the stock market's rally.
Source: Marketwatch

Yesterday several strong numbers came out including personal income and DPI, each rose by 0.7%. Improvement in income leads to higher consumer spending and eventually GDP growth, corporate profits and a bullish stock market. The PCE inflation measure was flat, signaling slowing inflation. This is key considering inflationary worries and concern over the FED hiking rates if inflation maintains high levels. Gold prices also dipped, strengthening the dollar and lowering commodity prices.

Economic Worries for the U.S. Economy

Despite weak GDP performance in the first quarter of 2008, the equity markets continued their climb today with the Dow closing at yet another record high. All of this came amidst talk of a potential recession, a weak Dollar, and declining markets abroad. With this seemingly unstoppable run continuing, there are still several factors that worry me about the current economy.

First off, let me make it crystal clear that I am still Bullish on the stock market and economy in the long run. However, there are too many factors signaling a struggle ahead. Lets begin with the inflationary pressure on the economy. The CPI and PCE both rose to suggest higher prices across the broad economy. Although prices in commodities continue to increase, I do not see these increases in the CPI and PCE repeating themselves for more then a few months. Commodity prices are being driven by international demand and growth, not domestic. Therefore, rising commodity costs are not being translated into actual inflation for most ordinary Americans except in the form of gasoline.

Another concern I have relates to the Fed's competence and the inverted yield curve it created. Greenspan is out, so I will wait to see how Bernake handles a fragile situation. Many bears argue we have never seen an inverted yield curve without a recession following. This fact is entirely accurate, yet may not be in this unique situation. The Fed mishandled rates in 2002-3 by sending them too low, creating the massive housing boom. Without properly limiting growth and speculation in the housing sector, the expected happened in when the bubble burst. Sub-prime spillover and sharp declines in housing prices and sales are not what worries me though. The drastic lowering of interest rates was overdone compared to inflation numbers. Additionally, it hurt the USD, which dropped steeply between 2002-4.



In an attempt to try and generate a perception of normal inflation, the Fed has increased the amount of money it prints to provide a short-term wealth. This will only worsen inflation in the long run as prices of goods and service remain constant the value of the dollar drops even more. To help control inflation, the Fed keeps focusing on raising the short-term FF rate instead of both the short and long or just the long. This has created the inverted yield curve, which undervalues long-term lending. Why would anyone borrow for the long term when they can get short-term returns at higher rates? Not to mention, it makes the U.S. pay back larger debts sooner rather then later.

Lastly, corporate profit records of late have been derived from operations abroad, not domestically. These profits are good since the companies making them are many of those headquartered in America. But, the income and revenues being attained globablly does not help our economy in terms of GDP, employment, and other factors. When you consider most of the returns on the investments made internationally stay outside the U.S. boarders, it really has no net affect on our country except for aiding to drive the equity markets higher. Also, if you consider the gains of the Euro and Pound against the USD, it makes sense that these companies continue to report record earnings. It must be near impossible for Wall Street to predict income and revenues generate across the world, let alone exchange rates to translate those earnings and sales.

These are just some things to consider in the short-term. Once GDP growth heads back towards 3-4% in the 4th Quarter, you can be assured that a new big rally will begin. Unless, of course, the current rally just never dies. As Larry Kudlow says, "It's the greatest story never told" and I expect many Americans to continue to reap benefits of investing in stocks, mutual funds and ETFs.