Forex report for Feb. 17: Stimulus fatigue

A $787 billion bill that was so hurried, it is doubtful any Representative or Senator read the entire text. $311 billion in discretionary spending, much of it not until 2010 and 2011, $285 billion in tax cuts and $191 billion in increased benefits spending.

Will this stimulus help the economy in 2009? Last year’s $168 billion stimulus did almost nothing to bolster consumer spending, most of the money went into savings or to pay down debt. Obama advisor David Axelrod is already downplaying expectations, saying only that things would be in “much worse shape” without the bill.

Consumer spending is crippled by three factors, two real and one psychological. The economy lost 2.5 million jobs in 2008, three-quarters of those in the last four months of the year. The monthly job reductions accelerated in January and there is no economic rationale to expect improvement before the half year. These vanished jobs represent an absolute decline in consumer spending; no amount of possible unemployment benefits and personal savings can replace the lost wages. Until the unemployed find new work, the drain on consumption will diminish GDP and the feedback loop to further cutbacks in employment will continue.

A 7.6% unemployment rate means more than 90% of those who want work and are actively seeking employment have found it. These consumers are able to spend but some of their potential consumption is blocked by their inability to obtain credit. Commercial banks normally supply only about 20% of the credit in the economy. The balance and much of the credit for consumer loans is supplied by the shadow banking system, through firms that lend and then securitize their loans through the asset-backed market and allied financing methods. This market has been almost completely moribund since last fall. The normal loan velocity for firms that supply credit to this market is shut down because they cannot securitize and sell their existing loans to obtain the capital for new ventures.

The gloom over the economy is led by none other than President Obama, who has said the recession “will get significantly worse before it gets better.” Media coverage of the economy is almost completely negative. The effect on consumers, especially those who might be calculating a large purchase like a house or car can only be delay or forbearance. This psychological recession acts to forestall or eliminate spending as families that can afford purchases choose not to buy that new sofa or take a resort vacation.

The main goal of the fiscal stimulus package, in the words of its supporters, is the creation of 3.5 million jobs. Over the next 18 months Federal spending will strive to replace jobs lost with equivalent work or government employment. The effect on consumer spending will be delayed into next year. In the initial months of stimulus expenditures any employment gains will probably be overwhelmed by continuing jobs losses. For much of 2009 the stimulus will have negligible effect on consumer spending, the money simply cannot be spent fast enough.

The dearth of consumer credit and the collapse of the securitization market cannot be cured quickly even after the government formulates a bank rescue. Trust and confidence between the institutions that create and market securitized products and with the private investors who buy them cannot be restored in a matter of weeks. Nor can the enormous weight of toxic debt be lifted from the balance sheets of lending firms in short order. Here too it is likely that 2009 will see limited return of securitization activity and scant improvement in the availability of consumer credit.

If there is little to immediately expect for the economy from the stimulus can we say the same for the dollar? Will the lack of positive movement in the U.S. economy endanger the gains the dollar has made since last summer?

Here we move from absolute measures to comparative ones. By all standards except risk aversion the dollar is unlikely to surrender its edge to its European or Asian trading partners. The economy of the European Monetary Union fell faster in the fourth quarter, about a 5.9% annualized rate, than did the United States at 3.8%. Japan’s GDP shrank at a 12.7% annual pace in the fourth quarter. It was the third quarterly drop in a row and the worst fall since the 1974 oil embargo. Fiscal stimulus in Japan or the EMU will be no more effective or rapid than in the United States. In 2009, neither the European nor the Japanese economy will provide an advantage to its currency against the dollar.

Ben Bernanke has promised low rates for as long as necessary. He might as well have been speaking for all of his industrialized world colleagues. The convergence of central bank rate policy will remain in place for the next several quarters giving no currency a jump on the next upward rate cycle.

However, if the U.S. stimulus plan succeeds in stabilizing the American economy, the returning calm could prompt a return to the activity in the yen crosses. For the dollar rising yen crosses are a two-sided coin, providing strong support against the yen but weakening it versus the euro, sterling, Aussie and kiwi. But returning risk appetite will not resurrect the carry trade, which has been rendered pointless by rate convergence and it is unlikely we will see a long term positive trend in the yen crosses.

Economic stability may not be an exciting goal for a politician but if the Obama stimulus achieves that much (or that little) it may well have a positive effect on the dollar.

Joseph Trevisani

FX Solutions, LLC

Chief Market Analyst

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