Dawn Meson

First In, First Out for U.S. Economy

That’s the conclusion reached by this GFT Forex Blog post. The author says that as the first G7 economy to enter recession, back in 2007, the U.S. will also be the first to make a full recovery. The author continues, “The other way to look at the current economic situation is that if the U.S. economy does not recover, no one else will. Globalization has increased the mutual dependency of many countries. For export dependent countries in the Eurozone and Asia, a rebound in U.S. demand is essential for a recovery.”

That thinking is likely at the root of the dollar’s perennial status as a forex trading safe haven.  Even though there are periods when it’s seen as riskier than other currencies, traders keep coming back to the USD for safe (well, safer) online trading. However, will the USD maintain its strength when the global economy stabilizes? The author says that recovery will lead to “a new shift toward fundamentals” and a resulting focus on the large amount of U.S. government debt.

Economists have predicted that recovery could begin as early as 2010, so in the next few months, it’ll be interesting to track the USD and see if the “first in, first out” phenomenon also means that the USD is the first one to lose some of the spoils of the recession.

Posted By: The Great American Small Business Challenge

Consumer Confidence at All-Time Low

The January plunge in consumer confidence to touch an all-time low of 37.7 sparked a rally for the USD in online trading, although GFT Director of Currency Research Kathy Lien called the trend a “reflection of more panic selling and not optimism about US economy.” She cautioned that confidence may not be restored until job security is no longer an issue—but with unemployment spiking to 7.2% and most analysts predicting that recovery will not be possible until 2010 at the very earliest, increased consumer confidence may be very far off indeed. In the meantime, any dollar gains in online forex trading are expected to be ultimately insubstantial.

Given the dreary consumer outlook, it’s not surprising that fourth-quarter GDP also fell to the weakest level in 26 years and house prices dove another 18.18% in November for the largest recorded decline. The sole bright spot, according to Lien, is the projected increase in car sales in the next six months as consumers look to capitalize on the discounts being offered to move inventory.

Recession Outlook Grim

Most analysts agree that the dollar’s rally in online forex trading throughout the fall was bound to be ephemeral, and with 2009 underway, the EUR/USD climb back upwards has begun. In December 2008, the dollar was up almost 20% against a basket of currencies, but since then, the weakening forex trend has taken hold as the economy continues to worsen on rising unemployment numbers that reached a 26-year high last month, a still-soft home market, volatile stocks, and the increased risk of deflation.

A UCLA Anderson Forecast report in mid-December said that although crude oil prices have dropped dramatically, the resultant fall in the absolute level of consumer prices is likely to do damage to the GDP in the next three quarters, causing it to shrink by 4.1%, 3.4%, and 0.8% respectively. The report also predicts that spike in unemployment will continue through 2009, hitting a projected 8.5% in December 2009.

Risk, Returns, and Regret in Bond Investing

“It’s a conundrum.” This is what ex-Federal Reserve Chairman Alan Greenspan said of the state of long-term interest rates. The situation that exists—with short-term rates getting measured increases, while long-term rates haven’t moved much—is a topic of confusion for many people, not just Greenspan.

Now we are concerned with another conundrum: Principal guarantees within bond investments.

A new client of ours whom we will call Bob is retired, and relies heavily on a fixed-income. Recently, while rebalancing his investment portfolio, he expressed confusion over the status of certain bond funds that he has held for years. Bob told us he heard from a former colleague that his principal might not be guaranteed, even though he had invested in government-bond funds, which he assumed were safe. Now we had the difficult job of explaining to Bob that perhaps he had become tangled in a common misconception — that government bond mutual funds do not guarantee principal. Furthermore, income distributions that such bond funds provide are both inconsistent and unpredictable.

Government bonds and government bond trusts are principal guaranteed. But investing in bond funds is not done on the same terms. While an individual bond pays the owner a consistent amount on each coupon date, there is nothing “consistent” about a bond fund, and distribution depends entirely on how well each of the bonds within the fund fare. At any given distribution date, the amount of money received can vary greatly. Therefore it is not even appropriate to label a bond mutual fund a fixed-income product.

This means a lot to Bob, because he and his wife depend on a predictable number of dollars at consistent intervals throughout the year. If that income doesn’t come in as anticipated, his lifestyle can be affected dramatically.

We’ve seen misunderstanding of bond-fund investments perpetuate itself over the years. The reason why mutual funds do not guarantee principal is because they are open-ended. Shares are offered continuously, and have no maturity date. If there’s no maturity, there’s no date for principal repayment. Hence, no principal guarantee. Conversely, government treasury bonds, bills, and notes, and government-bond trusts do have a finite life, or a fixed maturity date. When these bonds mature, the principal is repaid. Hence, a guarantee of principal.

Let’s look at a specific example. When Bob spends $10,000 on 10-year government treasury bonds at 5-percent yield, he will receive $500 dollars of fixed income annually, and is guaranteed every dime of his initial principal at maturity — 10 years from the date of issue. These bond investments are backed by the full faith and taxing power of the United States federal government. If, on the other hand, Bob buys into a mutual-bond fund, even though the bonds in the fund are government treasury bonds, the fund itself has no maturity date. And there is no exception to this rule. The same system applies to corporate, municipal, and “junk” bonds; the issuing institution backs those bonds and the rating is determined by the institution’s ability to pay.

Bottom line: We are not trying to turn people completely off from investing in bond mutual funds. There are some appropriate uses (and we stress the word some) for bond mutual fund investments. The key is to understand what you’re doing. The potential risk and rewards need to be weighed so that no matter what the outcome of the investment, feelings of regret (from not being properly informed) won’t seep into the equation. If, like Bob, you are on a fixed income and therefore require a predictable and continuous stream of income throughout your retirement years, we urge you not to panic; but rather to review your portfolio and seek advice from a financial professional.

Rate cuts halt EUR/USD fall

Over the past few days, the euro has finally broken out of its weeks-long slump against the dollar. Federal Reserve Chairman Ben Bernanke announced on Tuesday that the Fed would be taking the unprecedented act of buying three-month commercial paper, and today, central banks around the world made coordinated reductions in the target lending rate. Anticipating an easing of the credit squeeze that has driven the dollar’s recent rise against the euro, traders sold USD and bought EUR in today’s forex trading. As of 4PM EST, the euro had made its biggest gain against the dollar in more than two weeks, moving from 1.3585 yesterday to 1.3658.

Vietnam Real Estate Market

At a seminar in Hanoi last week, banking officials said the real estate market’s stagnation has increased the risk of default by developers, most of them are not strong enough financially. They said more bad loans would surface if the market continued its stagnancy. It is estimated that 60% of the capital for real estate development comes from loans.

Figures from commercial banks show that the loans made up 10% of total lending last year, equivalent to VND50 trillion. Bad loans made up about 2%. Loans for the property sector in HCM City are estimated at VND25 trillion and Hanoi VND9 trillion. The central bank has recently issued an instruction asking commercial banks to assess their property lending to make sure they could get back their money on time. The central bank’s local branches in provinces and cities must closely watch real estate development to warn credit organizations of default risk in time. Central bank warns about property loans. The State Bank of Vietnam has issued a warning against property lending, which makes up a large share of total lending in the banking system.

A strong week for USD

Based on the price movement of EUR/USD over the past week, one could say that it’s been a strong one for the U.S. dollar. From a high of $1.47669 on September 25, EUR/USD has fallen to $1.40082 as of this afternoon. The past seven days of online forex trading have even featured the euro’s greatest one-day decline against the dollar. But there’s little to cheer about in the U.S. economic outlook, and EUR/USD moves have been driven far more by Eurozone bank failures and the reluctance of U.S. banks to lend, which has tightened up the dollar supply. This week, the European Central Bank has offered one-day loans of 30 and 50 billion dollars to help maintain interbank liquidity while calling for banks to turn in surplus euros at a rate of 4.25%.

It’s difficult to forecast how the passage or rejection of the revised bailout plan is likely to affect EUR/USD. The premature announcement last week of a “fundamental agreement” actually saw the euro gain against the dollar in that afternoon’s immediate forex trading. Though a failure by the government to intervene will likely damage both the dollar and the economy, the addition of hundreds of billions of dollars to the U.S. deficit could also have a deleterious long-term impact on the dollar’s position in the forex trade market. For now, it looks like a lose-lose situation for USD, notwithstanding the woeful economic news coming out of the Eurozone.

A “buying opportunity” for EUR/USD?

The dollar experienced a temporary surge against the euro early today as online forex traders anticipated an announcement that Congress had reached an agreement on the proposed bailout of Wall Street. EUR/USD had moved as low as $1.45599 before Sen. Christopher Dodd, chairman of the U.S. Senate Banking Committee, announced this afternoon that a “fundamental agreement” had indeed been reached. The reaction from the forex trading community was markedly ambivalent, especially in contrast to the stock market, where the Dow Jones had added just about 200 points as of nearly 3PM in New York; EUR/USD currently stands at $1.46150 and has moved primarily upward throughout the afternoon.

Click on image to enlarge.

As the ten-year chart above reveals, the past several months of EUR/USD price activity have been historically aberrant. Yet despite some worrying economic news and the likely impact of the bailout on the federal budget deficit, most currency trading analysts are either neutral or bullish on the greenback. FX Street’s Analysts Sentiment Index for EUR/USD shows 50% neutral, 33% bullish, and only 17% bearish. Daily FX likewise reports “effectively neutral speculative positioning” at this time.

However, Bloomberg has been reporting this week on some forex analysts who are emitting very distinct growls. On Tuesday, TD Securities economist Joshua Williamson said that U.S. deficit issues could push the dollar up to $1.95 per euro. And today, a research note from Citigroup called the current euro price dip a “buying opportunity.” The euro could move up to $1.53, according to the Citigroup report.

EUR/USD down over 2.1%

In today’s forex trading, the U.S. dollar suffered one of its biggest ever one-day losses against the euro on fears that the $700-billion bailout plan proposed by Treasury Secretary Henry Paulson will further exacerbate the growing federal budget deficit. EUR/USD stood at $1.4794 as of 6:41 EST, up from $1.4466 yesterday. Percentage-wise, the dollar was down over 2.1% according to Reuters Dealing, the largest one-day drop for the greenback since January of 2001. Since reaching a high of $1.3882 on September 11, the dollar has fallen more than 6% against the euro.

Mood Swings for EUR/USD

This has officially been the most volatile week for the global currency trading market since the Asian financial crisis of the late ‘90s. Interday trading of EUR/USD went through significant swings as the dollar gained ground on word that the U.S. Federal Reserve had chosen not to change interest rates, only to plummet against the euro on the shocking news that the federal government was rescuing American International Group with an $85 billion loan. The Bank of Japan’s decision to hold interests rates at their current level of 0.50% also contributed to the dollar’s decline in today’s forex trading. EUR/USD moved from 1.4121 yesterday to 1.4348 as of 4:18PM EST today.

Looking ahead, a bearish interest rate environment for the euro suggests that the dollar may actually gain ground despite perilous conditions in the U.S. financial market. A survey released today by Bloomberg also found forex analysts to be optimistic about the dollar, which they expect to benefit from a slowdown in European economic growth.