Today is Election Day in the US which is expected to dramatically change the political landscape here in the US. While I normally try to avoid politics entirely, the impact that our current government has had on the shape of the economy has actually made things worse and today’s election may reflect that disappointment.
The two major issues are increased government spending and unfriendly business policies that have left the US with high unemployment and a stagnating economy. Enter Bernanke and the Fed. While today’s election is important, I think it takes a backseat to tomorrow’s FOMC meeting where Bernanke is going to set in motion QE2, the size of which is uncertain.
Because the people are calling for reduced fiscal policy, Bernanke believes that he can counteract that sentiment by increasing monetary policy. I think this is likely to not have the intended effect he is looking for, and will actually further contribute to economic malaise. The idea that he can “inflate the debt away” by printing money is misguided, as inflation will creep its way into the economy in the form of higher food and energy costs. These are things that are NEEDS in this country and not WANTS; so with an official unemployment rate (let’s not even get into the subject of REAL unemployment) as high as it is this is bound to cause a lot of pain for a lot of people.
This sentiment is not lost in Australia, where the RBA unexpectedly raised interest rates last night to 4.75%. While conventional wisdom was that further easing in the US would cause Dollar weakness and thus Aussie strength, the RBA is actually ahead of the curve realizing that not only is a stronger Aussie inevitable, but QE2 will actually cause a bigger inflation problem in Australia than it will in the US! In addition, interest rates were raised in India as well.
Right now, all of the “hot money” is already flowing to commodities and emerging market countries as yield seekers invest in places where there seems to be the potential for economic growth. With current US economic policy as it is, unfortunately the US is not that place.
So this morning is setting up as a classic risk-taking day, with Dollar weakness driving stocks and commodities higher, as well the “risk” currencies.
In the forex market:
Aussie (AUD): The Aussie is higher on the RBA rate hike, as the anticipated inflation from QE2 is seen as detrimental to the Australian economy. Because the Chinese economy has not slowed down and commodity prices are higher, the RBA is hoping to get out in front of the inflation exported from the US. The Aussie is now above parity with USD. (Click chart to enlarge)
Kiwi (NZD): The Kiwi is higher on Dollar weakness and riding Australia’s coattails.
Loonie (CAD): The Loonie is higher on Dollar weakness and higher oil prices which are now trading at $84. Canadian employment reports are due out on Friday.
Euro (EUR): The Euro is higher as well trading on anti-Dollar sentiment as well as the fact that PMI figures came in higher than expected. The Euro is trading above 1.40 vs. USD and looks poised to make a run higher. (Click charts to enlarge)
Pound (GBP): The Pound is mostly lower as PMI figures came in lower than reduced expectations, yet it is still holding on vs. USD. The Pound had advanced from the June lows more than the Euro so perhaps a little Pound weakness is in order to help the UK navigate through the waters of austerity.
Dollar (USD): What more can be said about the Dollar? A lot of the rhetoric is that we need lower interest rates to encourage spending to re-flate the economy to return to economic bubble levels. Here’s a news flash: we may never get back to those levels despite bankrupting ourselves in the process. Yet the contrarian in me says that this Dollar-weakness trade is just too easy, so there must be a scenario under which the Dollar can strengthen, right?
Yen (JPY): The Yen is weaker across the board on risk-taking and general Dollar weakness.
So is there a scenario which would strengthen the Dollar? At this point, because of the build-up to this announcement, the Fed has to take some sort of action that is significant. Otherwise, their credibility would be completely shot. There was ample opportunity to talk down the threat of QE2 in the same manner that it was talked up, yet that opportunity wasn’t taken. So it’s possible that QE2 is already baked in to price and that tomorrow will be a “sell the news” kind of day.
While the market would be disappointed if QE2 was smaller than expected, there would be a general sigh of relief. In this regard, I can’t see the markets selling off too much. Let’s face it, the ship is already sailing whether Bernanke launched it or not. Whether he decides to step on the gas is another question.
When I think of human nature, I’m not sure I would want to go down in history as the guy who piloted the ship into the iceberg. After all, everyone remembers the captain, but no one remembers the navigator. So when things seem too easy, sometimes they are. While I have no specific reasoning and am grasping at technical straws to support my gut feeling, I come up empty.
But sometimes you have to listen to your gut.
Tomorrow is going to be the type of day where both great fortunes are made and lost. Be cautious in your trading and investing, as volatility could be the likes of which you’ve never seen.
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