What is worse, inflation, a weak dollar or the credit crunch?
Written by A Forex View From Afar on Tuesday, April 22, 2008Back to www.thelfb.com
It was very apparent some time ago that equities would need to go head-to-head and deal with higher commodity prices before they could break topside and easily hold, and it appears that they have reached that time with oil at $120, and the major equity markets in the Red because of it.
Oil could not have reached today’s high without the weak US$, commodities are priced internationally in Dollars; one cannot go up too far without the other going down. The Euro just reached 1.600, the Pound is at two Dollars, the Swissy is at parity, as is the Cad, and it looks as though the Aussie is going that way as well. All this helps keep the Dollar Index scraping along the bottom of the 71 area. It may be noted that the Index stood at 100 in 2002; we are off by 30% in 6 years, and a lot of that is helped by the rise of the Euro that makes up 60% of the value.
Equities have plodded along through the Dollar demise, but now things may have to come to a head because a weak Dollar and higher commodities are stopping the Equity markets from moving onwards and upwards.
The markets only needed to be given a good reason to sell the Dollar lower, and push it through the 80 mark on the Dollar Index, the sentiment had been building negatively since 2003. They got it in the form of sub-prime in July of 2007, and a 300 points rate cut in less then 6 months.
The big problem that the Fed, and therefore the equity market too, is facing now is either to solve the Credit Crunch and housing problems, or fight Inflation and save the Dollar. In fighting Inflation with a stronger Dollar they would help to reduce Global Inflation by automatically reducing commodity prices. Two tasks, that require totally different, and extremely opposite actions: to either cut, or raise, Interest Rates.
Another added problem for the Fed is that the world demand for commodities has not slowed, especially in the past years when the US was entering a slowdown and contraction in its Business Cycle. Bad timing for the Fed; the US catches a cold, and the World now writes the prescription, with of course, Chinese made drugs it would seem.
It was reported recently that for the first time in the last decade, the demand for energy and commodities from emerging countries has overtaken US demand. This is an important aspect for the energy markets, and will probably make the Fed and other central banks revise their CPI expectation higher, inline with the need to now be dealing with basic commodity prices that are working purely on supply and demand, but with the demand outside of the historical norm.
A higher CPI is not good for the US economy at this point, the politicians and administration will not like the idea of delaying the housing recovery this year, and the government especially will not want higher interest rates, neither this year nor next due to the huge Current Account and Trade deficit. These deficits are easier to reduce with a weak Dollar, yet even so the numbers are not reducing in-line with a Dollar that is at historical lows. If rates increased the dollar gets stronger and the Trade Imbalances soar. The government pays a fortune in interest charges for servicing the debt, and higher interest rate will only make the Twin Deficit Balances that much worse.
Back to today’s main problem, which will probably last some time; high energy prices are a dangerous problem for the US Economy. They affect consumer spending, which makes up 70% of GDP, business expansion and of course confidence. All three are essential to Company profits, and in turn are affecting the equity market performance.
Mr Bernanke is piloting a heavy ship right now, and the storm clouds may not have cleared just yet, but until commodity prices come down the equity markets may be stuck spinning their wheels for a little while. They are holding higher ground, but moving forward can only be done once the Fed decides where they are taking the economy.
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