The summer doldrums are traditionally considered to be at an end after the extended, Labor Day holiday for the US. However, with the return of liquidity hasn’t been a positive milestone for the dollar. In fact, since the market’s ranks have filled back out, the dollar has been driven to a new a new low for the year. Yet, even with the bearish pressure, it is clear that the market is still hesitant to build momentum behind a bearish trend that is already six months in the making.
The Economy and the Credit Market
The summer doldrums are traditionally considered to be at an end after the extended, Labor Day holiday for the US. However, with the return of liquidity hasn’t been a positive milestone for the dollar. In fact, since the market’s ranks have filled back out, the dollar has been driven to a new a new low for the year. Yet, even with the bearish pressure, it is clear that the market is still hesitant to build momentum behind a bearish trend that is already six months in the making. The fundamental considerations are still the same. What economy is recovering from its recession the quickest and with the least amount of damage; whose interest rates will recovery first; and what long-term weights have been saddled during the worst of the of the financial crisis that will in turn prevent a healthy revival in capital markets. The US seems to be a laggard on all three fronts. A fresh 26-year high in the jobless rate points to a strained return of growth at the very least. What’s more, history has shown us that policy officials have waited a year or more after unemployment has peaked before returning to rate a hawkish policy. From a market perspective, record deficits are just one facet of a recent report that shows America losing its investment appeal. While it may be a very remote possibility in the near term, the attack on the dollar’s reserve status is still certainly tangible.
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A Closer Look at Financial and Consumer Conditions
The world’s financial system is still transitioning from stabilizing to improving; but the there are certainly setbacks and stalls along the way. For the US – the largest economy in the world – the road bumps are made much more prominent given its role as the rudder for the global markets. Bank failures continue to rise and access to credit is still a struggle for investors as much as it is for consumers. In fact, the World Economic Forum recently reported the United States ranked 106th for access to access to financing. There is also a growing interest in the long-term effects of the recent financial crisis and the efforts made to bring it to an end. Record budget deficits and new regulations will stifle foreign capital’s flow into the US.
While the United States is experiencing a fast revival from its record-breaking recession (Fed President Fisher said the recovery could resemble a ‘check mark’), it is still far from a strong expansionary cycle. An objective looking at long-term economic readings actually suggest that the return to growth will be slow and inconsistent. Today, the Beige Book reported that all 12 districts reported signs of improvement; but loan demand was ‘weak’ and wage pressures were ‘minimal.’ The real disconnect is labor markets which were consistently struggling across the board. Evidence to that was the quarter-century high, 9.7 percent jobless rate reported last week. This clearly wipes out any bullish sentiment from the previous month’s downtick.
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The Financial and Capital Markets
While the US dollar continues to struggle, the capital markets maintain their bullish trajectory. Whereas the low benchmark US lending rate is a significant burden for the currency when its peers are closing in on rate hikes more quickly, investors are simply looking for return. More and more, it seems the advance in asset classes like stocks, corporate bonds and commodities has more to do with capital gains and the reinvestment of massive stores of wealth that are still sidelined for safety reasons. It is true that there is a considerable amount of capital still tied up in treasuries, money markets and other low-risk assets (and its reintroduction to the speculative arena can naturally float all target areas of investment); however to actually draw funds back into these markets, there must be a reasonable expectation of yield and tempered risk. Considering the slow recovery of the global economy, the potential for higher rates led by inflated benchmarks and money velocity looks more than flimsy. Just like the recovery itself, the rebound in the markets over the past six months can be chalked up to stabilization. From here on in, expansion will come on the economy’s fundamental merits.
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A Closer Look at Market Conditions
Over the past week, we have seen the return of liquidity have a positive impact on the capital markets. As market participants return to the market they put their positions back on the books and naturally lift indexes. The Dow for example has rallied the past four sessions. However, this same index has yet to overtake its August highs. Realistically, this top holds little significance as the bullish bias holds its own. Yet, it is really momentum that we should be concerned in though. The conviction of the market’s advance can be measured through volume. With this gauge, we can see interest steadily declined with each milestone of progress made.
Volatility may finally have found a point of equilibrium. We have seen activity gauges for the various asset classes stabilize at lows not seen since before the worst of the financial crisis last year. Yet it is worth pointing out that the current levels are still well above the ‘normal’ of previous years. Does this mean we aren’t likely to see any more sharp market corrections? Most certainly not. The US economy is far from a strong pace of growth, banks are still failing, earnings are expected to contract going forward and net wealth is still shrinking. We must still keep our eyes out for potential shocks to the system – and the next one will probably come from sentiment itself.
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Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions? Comments? Send them to John at <[email protected]>.