What a Week: Dollar Dilemma
Liz Rappaport
11/24/06 - 01:45 PM EST
As shoppers hit the stores Friday morning, the stock market hit a wall.
The holiday-shortened week started out relatively strong, with a slew of merger activity featuring
Freeport-McMoRan's(FCX) $26 billion buyout of
Phelps Dodge(PD) and Blackstone Group's $36 billion offer for
Equity Office Properties Trust (EOP).
But the M&A news
failed to inspire buyers Monday and the week ended on a pessimistic note, largely spurred by deep declines in the value of the U.S. dollar. Whether the stock market uses the dollar as an excuse for more selling will be seen next week when Black Friday sales are tallied and the next round of economic data pours in.
In a shortened trading session Friday, the three major averages slipped within the first hour of trading, but rebounded somewhat as the session wore on. By the 1 p.m. market close, the
Dow Jones Industrial Average fell 0.35% to 12,283.37, down 0.5% for the week. The
S&P 500 fell 0.3% Friday to 1401.27, and was essentially flat for the week, while the
Nasdaq Composite slid 0.2% to 2460.26 Friday but rose 0.6% for the week.
The real drama was on the currency trading floors, however, as the dollar continued to plunge against the euro and the Japanese yen after weakening Wednesday. On Friday, the dollar fell through and stayed below key resistance levels -- the euro at $1.30 and the dollar at 116 yen. By the end of the New York trading session Friday, the euro rose 1.05% to $1.31, a 19-month high, putting it up 2.5% on the month vs. the greenback and 10.6% on the year, according to Ashraf Laidi, chief foreign exchange analyst at CMC Markets. The dollar fell 0.3% to 115.87 yen Friday, a three-month low.
Several trends are responsible for pushing the dollar over the edge this week, including foreign central bank diversification out of dollar assets. Earlier this month, the People's Bank of China Governor Zhou Xiaochuan said the central bank
planned to diversify out of U.S. dollar assets, and his words echoed those of other central bankers in the Middle East, Russia and Switzerland.
Indeed, foreign dollar reserves have hit the high-water mark at many central banks, writes Tony Crescenzi, chief fixed-income strategist at Miller Tabak and a
RealMoney.com contributor. In late October, China's dollar-denominated reserves topped the $1 trillion mark, up from around $200 billion from 2001. Russia's reserves are about $270 billion, compared with $10 billion in 1998.
Foreign central bankers understandably worry that holding too many dollar assets puts them in danger if the dollar were to decline sharply. But they walk a fine line as their export-driven economies are supported by a not-too-weak dollar. On the other side of the trade, the U.S. needs foreign investment in dollar-denominated assets, most notably Treasuries, to finance its massive trade deficit, which declined in September, but remains at near record levels at $64.3 billion.
Treasuries rallied Friday, once again revealing traders' sanguine view of the foreigners' diversifying story. The 30-year Treasury bond rallied 9/32 Friday to yield 4.63%, down from 4.69% last Friday (bond prices move inversely to yields). The 10-year note added 4/32 to yield 4.55%, down from 4.6% last week, and the two-year gained 1/32 Friday to yield 4.73%, down from 4.76% last Friday.
The dollar's weakness is not just about the diversification trend either. Investors fear a weaker dollar if the U.S. economy weakens enough to cause the
Fed to ease; amid lackluster economic news, odds of a first-quarter rate cut have increased sharply in the past week in the fed fund futures market. Also hurting the dollar are currency traders chasing performance by jumping into the euro, as others unwind the carry trade, which involves borrowing money in low-yielding currencies to invest other higher-yielding currencies and their assets, writes Laidi.
The price of gold, which typically moves in the opposite direction of the dollar, was on the rise Friday, climbing 1.5% to $644.90 an ounce.
With gold on the rise and the dollar slipping, inflation becomes a greater potential threat. The price of imports, like oil, rise as the dollar loses its purchasing power. So while a relatively weak dollar is often considered bullish for stocks -- particularly multinationals who garner revenue from overseas sales in stronger currencies -- a sharp drop in the dollar can mean trouble at home.
The dollar's break below key resistance levels Friday captured stock traders' attention Friday, even as the
Black Friday shopping session gets underway.
Though expectations remain high for this holiday shopping season, retailers were suffering in Friday's trade, including discounters
Wal-Mart(WMT) and
Target(TGT); apparel retailers
Ann Taylor(ANN) and
Abercrombie & Fitch(ANF), and; department stores
J.C. Penney(JCP), and
Nordstrom(JWN). The
S&P Retail Index declined 0.7% Friday, and was down 0.8% on the week.
In concert with traders' fears of a weakening economy, sectors like transportation, semiconductors and the brokerages were also on the wane Friday.
The
Dow Jones Transportation Average fell 0.4% Friday, and ended the week down 0.7%, while the
Merrill Lynch Semiconductor HOLDRs(SMH) closed down 0.4% Friday. On the week it is up a fraction. The
Amex Securities Broker/Dealer Index took a breather from its recent rally as well. It declined 0.4% Friday, but was still up 2.1% for the week.
The wobbliness of the rally and this economy's legs will be clearer next week when the Fed's Beige Book comes out, the government reports revisions to third-quarter GDP, and reports emerge on manufacturing, core personal consumption expenditures and durable goods. Likewise, the Fed may shed some light on the latest data in speeches next week by Fed Chairman Bernanke, Chicago Fed President Michael Moskow and Philadelphia Fed President Charles Plosser.
Until then, happy bargain hunting.
