Dollar’s Safe Haven Status at Risk Exposing Failing Growth, Rates

Credit Market

Previous

Current

Change

% Change

Outlook *

DJ Credit Default Swaps

105.964

112.998

7.034

6.64%

Deteriorating

10 Year Junk-Bond Spread

680.25

660.09

-20.16

-2.96%

Improving

Credit Card Delinquencies

4.77

4.64

-0.13

-0.13%

Improving

Mortgage Delinquencies

9.47

10.06

0.59

0.59%

Deteriorating

US 3 Month Libor Rate

0.345

0.304

-0.04172

-12.08%

Deteriorating

Total Money Market Funds

2815.78

2826

10.22

0.36%

Deteriorating

Stock Market

Last Week

Current

Change

% Change

Outlook

Dow Jones Industrial Average

10415.54

10060.06

-355.48

-3.41%

Deteriorating

Dow Jones Real Estate Index

199.71

195.34

-4.37

-2.19%

Deteriorating

Dow Jones Financial Index

325.68

311.74

-13.94

-4.28%

Deteriorating

Dow Jones Retail Index

82.59

80.8

-1.79

-2.17%

Deteriorating

S&P Volatility

24.59

26.7

2.11

2.11%

Deteriorating

Put-Call Ratio

1.92

1.97

0.05

0.05%

Deteriorating

Market Breadth (Adv - Dec)

0.2850

0.4643

0.1793

17.93%

Improving

Economic Indicators

Previous

Current

Change

% Change

Outlook

GDP (Annualized)

2.8

2.4

2.4

2.40%

Improving

Mortgage Applications

13

4.9

4.9

4.90%

Improving

Initial Jobless Claims

427

500

73

17.10%

Deteriorating

Consumer Confidence (UMich)

74

67.8

-6.2

-8.38%

Deteriorating

ISM Manufacturing

56.2

55.5

-0.7

-1.25%

Deteriorating

ISM Services

53.8

54.3

0.5

0.93%

Deteriorating

ISM Services - Employment

49.7

50.9

1.2

2.41%

Deteriorating

Over the past two to five years, the dollar has always had some fundamental foundation for which it could fall back on to establish at least a meaningful level of support. In currency market conditions, however, it is difficult to number relative growth and interest rate forecasts as elements of strength. That would still leave the currency’s status as a devoted safe haven asset as an alternative; but is this beneficial function at risk of diminishing in the near future? Recently, we have seen a round of significantly discouraging data and event risk cross the wires; and the subsequent performance by the greenback has fallen somewhat short of matching the intensity of the fundamental downturn. The source of this deviation can be traced to growing concern that the US may be foster another financial crisis and/or could tip back into recession. While both scenarios would very likely spread across the rest of the world to devastating effect, the risk that the world’s largest economy and market could suffer the relapse first and endure a greater intensity would likely dislodge the greenback’s role as a safe haven – with perhaps permanent consequences. This threat that investors pay greater attention to relative growth and interest rate potential for the US rather than underlying investor sentiment has its roots in important, forthcoming data and talk of another round of quantitative easing. The GDP revision is of particular interest because asset price deviate far from what the economy could reasonable provide. More complicated though is the growing speculation that the Fed will introduce a second stimulus package.

The financial markets are steadily deteriorating towards the level that panic could easily blossom and take over for rational investment. Much of the risk to the normal operation of world’s markets comes from outside the US. Europe’s profile as a threat has grown thanks to a downgrade in Ireland’s sovereign credit rating and the constant burden of high yields on sovereign debt auctions (a situation that is untenable given the economic and financial troubles these governments are already facing). China is another burgeoning threat. The risk that lending restrictions stalls growth or sparks a panic of capital losses only grows with time. Now we just wait for the catalyst. In the US, the threat/promise of further quantitative easing is finding greater traction after the Fed’s bond program.

The economic data released over the past week has significantly increased fear over the stability of the United States’ economic recovery. While there have been critical missing pieces to the recovery formula since speculative optimism took root last year, it has taken shockingly-bad, timely indicators to really get the market’s attention. The housing sector (the catalyst for the last recession) has quickly developed into an anchor on future activity with a record breaking drop in existing homes sales, which account for the bulk of deals in the sector. Further, as a reflection of credit conditions and consumer confidence, the 27 percent drop clearly reflects the pressure on Americans. Furthermore, the durable goods drop removes a key reading of support for the US. This Friday’s GDP revision could redefine the market’s outlook.

There was a hesitancy in following through on the tentative breakdown in the capital markets (which should be interpreted fundamentally as investor sentiment) last week because there was a distinct lack of data and significant uncertainty as to whether a trend would definitively form. This week, we have seen that fledgling unwinding of the risk built up in June and July pick right back up. This deterioration in confidence was picking up speed slowly until there was specific fundamental fodder for investors to attach their insecurities to. The severe drop in housing sales not only dramatically lowers the outlook for economic activity in the world’s largest participant, it further acts as a shock of reality for earnings expectations – where the outlook for dividends and higher yields was arguably never as high as the market’s fair value level would have suggested. It has been the case since last March that investor confidence has frequently deviated from fundamental moorings. However, given the intensified focus on economic activity and its potential impact on returns and financial stability; we may soon see cause and effect reconnect. Now we look to Friday’s GDP revision as a possible catalyst for the reconnection.

Capital markets have started to show real bearish progress over the past three weeks. After an initial reversal effort made back on the 11th, the financial world’s benchmarks would quickly lose momentum as investors looked for fundamental confirmation for what could be a meaningful trend reversal. Given the significant follow through and one-month low for the S&P 500 (two-month low for US Oil), we may be seeing economic catalyst meet speculative momentum. And, while this decline has been remarkable to this point; the real burden for a long-term bear trend remains in testing new yearly lows which are still significantly lower.

Both the typical and unusual measures of risk have shown signs of deterioration this week. The standard bearer volatility indexes have marked modest progress across the spectrum of asset classes. The equities VIX has advanced to a six-week high around 29 percent, the currency version has moved to a two-week high of 12.6 percent, and the gold reading advanced to its highest level this month at 19.6 percent. Far more interesting though are the unorthodox measures of risk. The spread between the Euro and US three month labor rate hit a 14-month high, the yield differential between three-month Libor rate and government bill has hit a four-month low (very unusual) and premiums for periphery European bonds are near records.