By Marc Chandler The outcome of the U.S. mid-term elections and Federal Reserve Open Market Committee meeting, coupled with the various economic reports, strengthens our base case scenario in which we expect the U.S. dollar to generally trade higher as the 2010 winds down. Many expect the dollar to decline in the wake of the $600 billion Treasury buying program of the Federal Reserve. In contrast, we emphasize the anticipatory nature of investors. The dollar's relentless decline in September and October was, in fact, the market pricing in QE2. As it became clear the Federal Reserve was going to provide more monetary stimulus, we anticipated roughly a 10% decline in the dollar that would carry the euro toward $1.40 and sterling toward $1.60. At the same time, we suspected that the dollar would not gain much traction until uncertainty around U.S. fiscal and monetary policy would be lifted by the outcome of the U.S. election and the FOMC meeting.
It is also difficult to extrapolate the terms of 2012 presidential election from the midterm results, which President Obama called a "shellacking." However, the Republican victory extended to the state houses and governors and this will have important implications for congressional redistricting based on the 2010 census.
A better series of U.S. economic data would be difficult to envision; all better-than-expected. This included both ISM reports, auto sales and the U.S. employment data (with 103,000 upward revisions in Aug and Sept). The details were also encouraging. In the ISM reports, not only did production/activity measures gain, but the forward-looking orders components were also stronger. The 12.3 annualized pace of auto sales represents a new high since the cash-for-clunker program ended. Industry reports suggest that households rather than fleets were responsible. With the revisions, October was the fourth consecutive month in which the private sector created more than 100,000 jobs. During these four months, the U.S. posted its best job creating record since early 2007. May and June stand out as particularly weak with a combined total of 112,000 jobs compared to the average monthly gain since of 131,500. Moreover the work week increased by 0.1%. This sounds meager, but given that there are roughly 131.5 million workers, working 6 minutes more is relative to income and output of another 380,000 workers. This improvement in the high frequency economic data is reinforced by the improvement in a host of financial variables. These include money supply growth, easing of credit conditions (as picked up in the most recent senior loan officer survey) and reflected in better consumer credit and commercial and industry loans. Namely, one credit rating agency reported that credit card defaults and delinquencies have begun slowing. None of this denies the structural constraints on the economy. Increasingly, however, and at a heavy cost, the current and ongoing recovery is on par with, and in many ways superior to, the (jobless) recoveries seen after the last two recessions.
Germany is insisting that after the EFSF expires in 2013, there will be no more bailouts. The cost of leaving the monetary union is prohibitively great. That would seem to leave only one option to resolving the intractable debt situation. Germany calls it burden-sharing with the private sector, created to minimize the taxpayer's exposure, while forcing creditors to accept larger haircuts. But, overall, it is debt restructuring plain and simple. The investment implications are driving funds into Germany and driving down interest rates. The U.S.-German 2-year interest rate differential snapped a five week trend in Germany's favor on November 5 and at 55 basis points, the premium Germany offers is smaller than its four-week moving average for the first time since early September. The lifting of the political and economic uncertainty that hung over the U.S., coupled with the somewhat better economic momentum, may allow the devolution of the situation in Europe to move into ascendancy. This was the basis of our call for the dollar to recover in the second half of the fourth quarter. While we are constantly monitoring developments, the script is thus far unfolding largely in line with our base case.