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The Dollar Next Year: Two Angles

An update from World First.

As we move into December it is necessary to bring you our thoughts as to movements of certain currencies in the coming year. We will aim to bring you views from both sides of the argument i.e. an argument for strengthening and an argument for a certain currency’s decline. In the first of this series we will look at the prospects of the most important global currency, the US dollar.

The case for the prosecution: a weaker greenback

The US is in a terrible state at the moment with a budget deficit as a percentage of GDP larger than anything since the end of WW2, while the money that it owes in the form of US treasury debt has almost tripled in the past year and is expected to expand by around $1trn a year for the next 15 years or so. This coupled with the expansion of spending needed to fund Obama’s healthcare plan, the ‘War on Terror’ and social security for baby boomers leads us to believe that they have two options; print more debt or hike taxes and slash spending.

As a fan, interested observer of American politics and a firm believer in Josiah Bartlet I think we can safely forget the last. Obama is not going to raise taxes on “middle America” this close to the mid-term elections and would not afterward for fear of giving the Republicans the White House back after his first term. Likewise he cannot cut spending at the fear of alienating moderate democrats and liberal Republicans when he needs to so much support on ramming through his healthcare plan Superman is in trouble and will have to do what all have done before him; spend like a drunken sailor.

This will continue in 2010 and therefore we are likely to see interest rates in the US continue to remain low for a very long time.  This should lead to a weaker dollar as other countries raise rates and attract inward investment on their debt. The US is now likely to move into a time in which it is comparatively a lot poorer than it has been in the past 100 years and could see its position as the global reserve currency threatened further.

The case for the defense: a stronger dollar

Those of my profession who are looking for a stronger USD over the next year or so are focusing on the first quarter of 2010 as the time in which the starting pistol will be fired. Quantitative easing should end in the US by March. QE has had a negative effect on long-term interest rate expectations and the belief is that as soon as the Fed stop their repurchase program we will see the market price in interest rate hikes towards the latter part of 2010.

Higher US rates may serve to weaken the prospects of emerging market investments (why take the risk when the return is comparable?) and benefit from its status as a haven currency Positive correlations to this probability have been seen over the past 10-15 years.

The other thing to bear in mind is the price of this debt in yield terms. The US are due to auction off close to $2.5trn over the course of 2010 with the Fed hardly absorbing any. This leaves other investors to pick up the slack. The Fed will not risk these issuances being undersubscribed and will post attractive interest rate coupons to the debt to attract the cash. That increase in interest rate should see a surge in dollar buying and a stronger dollar as a result.

Looking at the option market we have seen an increase in the cost of protecting against dollar strength, a sign of a market preparing for an onslaught. The price has risen so much that it we are not far from the price levels that were seen in the immediate aftermath of the Lehman bankruptcy for a three month horizon. It seems that the market is sensing a strong movement in favor of the US dollar around the end of Q1; an expectation that fits in with the possible Fed curtailing.

Conclusion: We believe that 2009 has been difficult to predict, however, it may be nothing compared to 2010 for the dollar market. With cues from the options market in particular we think a hedge via an options contract is the only sensible protection measure that can be taken. We are of the opinion that dollar will weaken in 2010 as the world continues to recover and the need for haven assets lessens but would still advise a protective hedge, an example of which is below.

Next week we will turn our thoughts on the euro.

Trade of the Week

This week’s trade of the week is a risk reversal from January to June. The client sells GBP and buys USD to pay suppliers in Taiwan. They had budgeted on the next six months of invoices at a GBPUSD rate of 1.62 on our advice, but were unwilling to use forward contracts to protect themselves as they believed that the pound would rise at some point against the dollar.

The client was able to achieve a worst case rate of 1.62on their option and they benefit up to a rate of 1.80. Should the GBPUSD rate be below 1.62 on expiry they are able to buy dollars at 1.62, if it is above 1.62 and below 1.80 they buy in the spot market and if it is above 1.80 they are obligated to buy at 1.80.

This strategy required a premium of 2.7% of the notional amount (the amount hedged), and is also relevant for sellers of sterling and buyers of other currencies. As there is a potential further weakening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight worst case rate.

For more information, see www.WorldFirst.com.

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China Dominates the Thanksgiving Table

An Update from World First.

The Pilgrims made seven times more graves than huts. No Americans have been more impoverished than these who, nevertheless, set aside a day of thanksgiving. ~H.U. Westermayer

American families will gather at this Thursday to celebrate Thanksgiving. It’s a time for family, a time of reflection and obviously, a time for giving thanks. The American family have not had much to celebrate over the past 12 months with consumer spending still depressed, house prices continuing to languish near the depths and a whopping health care bill still inching its way through the US Congress.

There is a division in Washington at the moment between the government’s currency talk and the government’s currency walk. The US government and Americans in general like to get behind a rallying symbol; baseball, apple pie, the star spangled banner but recently they had been beating the “strong dollar” drum.

Americans love a strong dollar. It’s a gesture of strength. The division is this: the dollar must stay strong to prevent foreign governments selling the debt that it has been chucking out for years and years. At the last calculation we believe that around 34% of US debt is held by foreign governments with the majority of that being held by the Chinese and Japanese. A significant weakening of the US dollar would see the value of these assets shrink and puts selling pressure on the debt. However a weak dollar would also cut the economy’s reliance on imports, stimulate the export market and, in a country with 10% unemployment, create valuable jobs. Ceteris paribus, you would then see consumer confidence pick up alongside consumer spending and a general improvement in the US economy.

We are still happy with our predictions that we will see dollar weakness over the course of 2009. We may not see the rate of decline that we have seen this year; dollar has weakened by 14% against sterling this year. A similar move from current levels would see GBP/USD at 1.89 in 12 months time but we doubt that the market would allow sterling to appreciate that much through a year that includes a general election.

Obama and Geithner, like Bush and Paulson before them, have a delicate balancing act to consider. It is certainly my opinion that we will not see a revaluation of the Chinese Yuan against the US dollar soon; there is very little incentive for the Chinese government to change the current dynamic.

The Americans will have to obey the golden rule: he who owns the gold, rules.

All this and more is available at www.worldfirst.com/blog.

Trade of the Week

This week’s trade is a risk reversal from January to June. The client sells GBP and buys EUR to pay suppliers in Germany. They had budgeted on the next six months of invoices at a GBPEUR rate of 1.09 on our advice, but were unwilling to use forward contracts to protect themselves as they believed that the pound would rise at some point against the euro.

The client was able to achieve a worst case rate of 1.09 on their option and they benefit up to a rate of 1.18. Should the GBPEUR rate be below 1.09 on expiry they are able to buy euros at 1.09, if it is above 1.09 and below 1.18 they buy in the spot market and if it is above 1.18 they are obligated to buy at 1.18.

This strategy required a premium of 1.4% of the notional amount (the amount hedged), and is also relevant for buyers of sterling and sellers of other currencies. As there is a potential further weakening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight worst case rate.

For more information, see www.WorldFirst.com. 

Weekend Update

Special Update from World First.

There is nothing worse than speaking to a depressive on Friday afternoon. Like a friend who texts on a Friday night “Only 2 days ‘til Monday!” some things we are happy to pretend to not have seen. The 500lb elephant in the room keeps trumpeting away, however, so let’s address him. We have started to see more and more analysts and commentators pointing towards a fall off in fortunes over the Christmas period; potholes and sleeping policeman in the road to recovery if you will.

These analysts expect to see such things in the coming months:

· Equity markets to begin to fall off heavily

· Dollar strength as risk averse investors jump back into US treasury bonds and bills

· GBP weakness as banks come back under pressure from balance sheet issues.

These are not the thoughts of some crackpot holed up in their bedroom and the justifications are listed below:

· US mortgage defaults have risen to a new record high. Now over 14% of all mortgages in the US are either already in foreclosure or at least one monthly payment behind.

· The number of positions betting on US dollar strength are at the highest level since this time last year.

. US consumer confidence and spending levels are still depressed with the only industries benefiting are artificially strong due to government stimulus (Cash for Clunkers, for example)

We are still very happy with a strong sterling outlook over the balance of next year but the lessons of last winter may need to be revisited. Personally I think you could do a lot worse than hedge around these levels.

For more information, see www.worldfirst.com.

Currencies in the News

An update from the currency exchange firm World First.

We had several pieces of big news last week, the headline grabbers were US unemployment jumping to 10.2%, BoE Quarterly Inflation Report and the news our friends spending the single currency had exited the recession.

The week began with concerns over the recovery in the US with unemployment posting higher than expected.  This added fuel to the argument regarding the greenback’s status as the global reserve currency and is a debate that refuses to go away. We have had further mutterings from Singaporean APEC conference that the Chinese Yuan may have to be revalued to increase its competitiveness.  It seems that the Yuan is certainly the main contender to dethrone the dollar but until the Chinese entertain floating their currency it seems the argument may be redundant.

In the wake of the poor US data we had the news that Europe had emerged from recession.  It must be said that the emergence was met with little fanfare due to a slightly disappointing GDP figure out at 0.4% against an expected 0.5%.  This happened on Friday and had little effect on GBPEUR, also leaving EURUSD flirting just below 1.50.

The news from Brussels was punctuated the day before by the BoE quarterly inflation report.  The market was looking to comments made by Merv the Swerve to place a firm hand on the tiller of the UK fiscal policy and outline a clear path forward.  In typical fashion, King’s mantra was that the Bank had decided to inject a further £25bn (bringing the total to £200bn) at the last BoE meeting, and the committee would continue to assess the situation and do what was required.  He did state that he felt that measures implemented by the Bank had worked well so far.  King was very cautious but when drawn to comment on the warnings made by Fitch that the AAA UK credit rating was “the most at risk.” He did state that although he would leave the decisions to the Credit rating agencies, he saw no reason for the UK’s rating to come under threat.  He also noted that a period of austerity was clearly required, and simply said that the pre-budget report alluded to a state of saving once the economy returned to growth.

He finally allayed many fears regarding the surprise UK GDP figure for Q3.  Governor King said that all projections are just that and stressed that the important thing was that the figure was progressing along the predicted trend.

The big news of the week will again come from the Bank with the release of the BoE minutes at 9.30 on Wednesday.  As ever, we will be looking to see if the minutes set a definitive tone for the direction of QE and the voting split may provide an insight. With the Bank notoriously tight lipped this will be particularly interesting.

Trade of the week

This week’s trade of the week is a Convertible Forward until May. For a GBP seller and a buyer of USD, this client took advantage of the uncertainty in GBPUSD in order to protect themselves against falls while being able to benefit should the market turn higher.

The client was able to achieve a worst case rate of 1.6550 on their option which allows them to benefit all the way up to a rate of 1.80. Should the rate touch 1.80 during the barrier period (one month before the expiry date) then the structure reverts to a forward at 1.6550.

This strategy requires no premium, and is also relevant for buyers of sterling and sellers of other currencies. As there is a potential further weakening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight WCR.

For more information, see www.worldfirst.com.

See disclaimer below.

Win a Trip to Toyko

Write your way around Tokyo, all-expenses paid, and get published to boot! WorldNomads.com in conjunction with Rough Guides, Intrepid Travel and Hotels.com announces a contest for aspiring travel writers ages 18 and up. Candidates can be students, emerging and non-professional writers and lovers of travel looking for a career change.  The prize is the chance to travel for a week, all-expenses paid, to Tokyo and learn tricks of the trade from Rough Guides travel writer, Simon Richmond.

The deadline for applications is December, 21, 2009. For details and online entry please visit the scholarship page on WorldNomads.com.

The assignment will be to research, review and update essential travel info for the Tokyo section of The Rough Guide to Japan, including accommodation, bars and restaurants, entertainment, shopping, tours, activities and transport, as well as searching out those local secrets that travelers want to read about.

The contest winner will fly to Tokyo from his/her country of residence and then, after touching base with travel writing mentor Simon Richmond, hit the road for seven days reviewing and writing for The Rough Guide to Japan (See www.roughguides.com/website/shop/products/Japan.aspx) travel guide. Afterward there will be a chance to relax and enjoy four-day “Flavors of Tokyo” independent tour with Intrepid Travel offering a cuisine-focused insight into the Japanese Culture.

Applicants need to be available February 15 - 26, 2010 to participate in The Rough Guide to Japan writing assignment and “Flavors of Tokyo” independent tour with Intrepid Travel.

Entrants must have a high degree of proficiency in written English, be comfortable doing some travel on their own, be at least 18 years old, have a current passport and be an excellent writer with a lust for adventure travel and a burning desire to be a travel writer.

To apply entrants will be asked to write a maximum 500 word travel-focused essay based on a personal experience around one of the following themes:

-A Journey that Changed Lives
-Responsible Travel
-Adventure in an Unknown Culture
-A Memorable Experience Involving Food in a Foreign Country

The winner of the contest, along with the best entries received will be published on WorldNomads.com on January 8, 2010. WorldNomads.com provides global travel safety products and services to travelers from over 150 countries. From travel insurance, travel safety advice, language guides and free online travel journals, WorldNomads.com provides the tools to keep clients traveling safely. Clients may donate to a community development project when purchasing travel insurance through the Footprints Charity program. The company is backed by a suite of strong, secure, specialist travel insurance companies.

Forbes Top 10 Retirement Havens

Forbes, the business magazine has compiled a list of the top 10 destinations for Americans retiring abroad. They are:

Austria
Thailand
Italy
Panama
Ireland
Australia
France
Malaysia
Spain
Canada.

Factors considered were costs, safety, medical care, ease of obtaining a visa, political stability, public transportation and availability of flights home.

The article disparages other sources which promise a champagne retirement on a beer budget, but it does acknowledge that Panama and Thailand are places where Americans can retire cheaply. (Note: We have an article on Panama at www.liveabroad.com/articles/panama.html). Maybe we should also have one on Thailand, which offers the “O” visa to retirees with a minimum of $24,000 in a bank account and $1,935 per month in income.

In contrast, Australia, which is also on the Forbes list offers an “investment retirement visa” requires that a minimum annual income of $56,000 or $43,000 in rural areas as well as $650,000 minimum to invest locally or $430,000 in a rural area.

Notice that Mexico, which has more U.S. retirees than any other country, isn’t even on the list. Safety is noted as a factor. The article says that teenagers out on the city in Monterrey are apt to be followed by their body-guards. Brazil is dismissed because of its high murder rate. However, both Brazil and Mexico are very large and diverse countries countries with areas where expats live comfortably and safely.

Costa Rica, second only to Mexico in drawing retirees from the U.S., is dismissed because of its red tape, among other things. Its proximity to Honduras is also cited as a drawback. However, Costa Rica was a popular expat destination when Nicaragua was far more turbulent than Honduras is now.

Forbes admits that there are many things to consider in choosing a retirement haven. Affordability is tied to health care costs, Most foreign countries require that retirees have their own health insurance so that they don’t become a burden to the local taxpayers.

The article advocates looking carefully at local taxes. France is tax friendly to retirees though not to entrepreneurs. So is Ireland, where a couple over 65 is entirely exempt from Irish tax on any income under $59,000. The article mentions a couple happily retired in Paris where they withdraw their earnings from their U.S. Merrill Lynch account.

Although Forbes is geared to high-income readers, we’re glad that the idea of moving abroad strikes their editors as a subject worthy of the magazine’s attention. This article doesn’t go far enough, but it does caution readers to consider both their priorities and their budget. That’s a good start.

Indecision is Final

An update from the currency exchange firm World First

The schizophrenic nature of markets was again illustrated by sterling’s contrasting performance from the beginning to end of the week. The hangover from last Friday’s shock negative GDP sent the pound into a nosedive against both euro and dollar.  This was in spite of talk that the dollar was under the cosh. The Euro, as ever, maintained its position as the pick of the trio and even touched 1.5050 against the dollar. Its position was helped by comments from Chinese officials indicating diversification away from the dollar across to the euro as the global reserve currency.

The USD benefited early on in the week when a downgrade of several US banks saw risk back on and furthermore, served as a reminder of just how volatile the currents that run beneath FX markets still are.  USD data has generally surprised to the downside during the crisis.  As with US GDP and several other key indicators this trend seems to be reversing.  This causes any more negative releases to invoke the same risk aversion trading that we experienced during the beginning of the meltdown after Lehman’s failure. The more positive USD surprises will encourage risk and assuage concerns regarding the recovery.  Consequently, we can expect a weaker USD long term.

GBP movement north against the EUR was due to the concerns regarding European competition rules on the subject of banking regulation, a similar weakening of European banking stock on the equity markets was also observed.  The pound kept pace with the greenback as the end of the week saw US data increase risk appetite.

The following week sees the busiest calendar in the FX markets for some time and subsequently a plethora of event risk. We have the FOMC meeting on Wednesday, expecting they maintain their rhetoric regarding the need for economic conditions"‘to warrant exceptionally low levels of federal funds rate for an extended period.” This will be positive for risk and USD negative.

We then follow the next day with both BoE and ECB meetings.  We can expect the ECB to hold rates steady but with Norway the first euro zone country to raise interest rates we cannot expect the single currency to be light years away from it and given the ‘hawkish’ nature of Trichet et al. hints may be given in the post-decision press conference.

Having seen the US approach to the crisis bearing fruits it highlights the market difference in approach.  The most important sentiments we hope to hear from the BoE are that of decisive and precise action; a categorical statement that either QE is finished or an exact final amount that will be allocated would bode well for the pound in the future.  With inflation figures in the UK still very low, GDP still negative, a country in recession and the previous form of the 9 voting members it seems odds on, around 70/30, for more stimulus.  However, it is impossible to predict the future so we shall just have to wait and see.

The week is not finished though; we round off with US non-farm payrolls.  As you can see the event risks are monumental so strap on your seat belts because this week is about as exciting as FX markets get.

For more information, see www.worldfirst.com.

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