“Maverick McCain” and the Resurrection of the US$
by Gary Dorsch, Global Money Trends. September 9, 2008
“As soon as you think you’ve got the key to the stock market, they change the lock,” lamented Joe Granville, who is mostly remembered for his bearish calls on the US stock market during the 1970’s, 1980’s, and the 1990’s. Nowadays, many currency traders are scratching their heads, trying to figure out what’s behind the sudden resurrection of the US-dollar, which has been flexing its muscles, and bucking conventional logic by climbing sharply higher against all major foreign currencies, including those that offer much higher rates of interest.
The Euro has plummeted 12% vs. the US-dollar tumbling to as low as $1.410 today. Euro-zone Finance chief Jean-Claude Juncker was happy to give currency traders the green-light to trash the Euro this week. “Things are developing in the right direction, in line with the commitments of the US Treasury that it stated in recent months. The Euro is less than $1.44, and it reflects economic fundamentals better than the Euro flirting with $1.60. I still think that the Euro is overvalued, not only against the dollar, but also against other currencies,” he said.
There’s been a major shift in market psychology surrounding the US-dollar that’s caught many currency traders by surprise. Until July 15th, the key driver fueling the Euro’s historic advance against the US$ was a widening interest rate advantage. In Frankfurt, Germany’s 2-year yield rose to as high as +220 basis points above the comparable US-T-note in June, and up sharply from a negative -80 basis points in April 2007, which in turn guided the Euro on a steady climb higher to $1.600.
Today, the German 2-year schatz still commands a hefty +165 basis point advantage over the US-T-note, which just a few months ago was sufficiently high enough to buoy the Euro within a tight range of $1.540 to $1.600 in the second quarter. And there’s no indication that the Euro’s wide interest rate advantage over the US-dollar is about to shrink in the months ahead, neither by a series of rate cuts by the ECB, nor by a series of rate increases by the Fed.
On Sept 4th, ECB President Jean-Claude Trichet ruled out a rate cut anytime soon. “We just increased interest rates in July to 4.25%, to deliver price stability during the course of 2010. We never pre-commit, and we always do what is necessary to maintain price stability. At face value, today’s press conference should have dispelled any rate cut speculation for some time,” he warned.
On the flip side, the Fed won’t raise rates after the US jobless rate jumped to 6.1% in August, a 5-year high, and 605,000 workers have lost jobs this year. In contrast, the US economy created 1.1 million jobs in 2007. Eleven US banks have failed so far this year, and the FDIC classified 117-banks as a “problem” in the second quarter, up 30% from the first quarter. Nearly 1.2 million US homes are in foreclosure, weighing on the fragile market with no bottom in sight for home prices.
“You simply must accept that the credit crisis is far from over,” warned Federal Deposit Insurance Corp chief Sheila Bair on Sept 4th. She urged banks to strengthen their reserves. “It’s a tough slog but there’s no easy way out,” she said. Bair expects more US bank failures and if the FDIC’s $45 billion insurance fund isn’t sufficient to meet the crisis, the FDIC can tap into a $30 billion long-term line of credit with the US Treasury Department and up to $40 billion of short-term credit.
Even a rash of US bank failures and the possible collapse of Lehman Brothers, LEH, Wall’s Street’s fourth biggest investment bank, a big player in the sub-prime mortgage market, hasn’t put a dent in the US-dollar’s newly minted Teflon armor. Lehman’s 8% preferred-J shares plummeted today to $8 per share, lifting its junk-status yield to 25%, after an eleventh-hour rescue attempt by the Korea Development Bank (KDB) was placed in doubt.
True to form, the credit rating agencies are still touting LEH’s credit status at single “A” even though the company is locked out of the credit markets. And where there is smoke, there is fire! The cost of protecting Lehman's debt with credit default swaps for five-years rose to 450 basis points, or $450,000 a year to protect $10 million of debt, up from 325 basis points the previous day. When a bank loses the confidence of its customers, it can evaporate very quickly, just like Bear Stearns.
Less than 48-hours earlier, the US government seized mortgage giants Fannie Mae and Freddie Mac, a move that could potentially cost US taxpayers $200 billion. The US economy lost 84,000 jobs in August, and has shed jobs for eight straight months, something that has happened only eight other times since the end of the World War Two. In each instance, the string of job losses signaled a recession.
Arab Oil Kingdoms Flock to US-Dollar
Yet despite all this bearish news for the US-dollar, currency traders are putting a positive spin on whatever mud can be thrown at the greenback. What’s behind this sea-change in market psychology towards the US-dollar, where the focus has shifted away from interest rate differentials, and instead, has veered-off towards other key factors? They were highlighted in the August editions of Global Money Trends.
Throughout the US-dollar’s tortuous 40% slide over the past six-years, the Arab oil kingdoms in the Persian Gulf stayed loyal to their archaic US-dollar pegs, even while the Fed’s indifference to the sliding US-dollar sent inflation shock waves through their dollar-linked economies. The Arab oil kingdoms rescued the US-dollar from the brink of collapse by rapidly expanding the supply of Kuwait dinars and Saudi riyals, and recycled about $250 of Petro-dollars into US Treasuries over the past 12-months through their brokers in London.
Saudi Arabia’s M3 money supply is 21% higher from a year ago, fueling inflation to +11.1% in July, it’s highest in 30-years. In Abu Dhabi, the biggest member of the UAE federation, prices were 12.9% higher in June. In return, the US armed forces defend the Arab Oil kingdoms from their dangerous neighbors to the north in Iran, which seeks nuclear weapons, and is closely aligned with czarist Russia, and Venezuela’s mercurial kingpin Hugo Chavez, forming the “Axis of Oil.”
The recycling of Arabian Petro-dollars into US Treasuries put a floor under the US$ Index at the 70-level this summer, and persuaded bearish currency traders to cover massive short positions that had been built-up in the US$ over the past six-years. King Abdullah of Saudi Arabia upped the ante by boosting the kingdom’s oil output by 1.1 million barrels per day (bpd) from a year-ago to a record 9.7 million in July, which has deflated the crude oil bubble by a whopping $45 barrel so far.
On Sept 8th, OPEC chief Chakib Khelil said he expected the oil market to be oversupplied at the end of this year. “There is plenty of oil in the market, stocks are pretty good. There will be an oversupply of one-million bpd by early next year,” he predicted. Khelil also noted that oil prices were easing as the value of dollar rose. US crude fell to under $102 as the dollar hit an 11-month high against the Euro. “What we are seeing now is the inverse relationship between the US dollar and the oil price is verified. The dollar is strengthening, the oil price is going down,” he added.
OPEC hawks Iran and Venezuela have called on Riyadh to cut its oil output, and put a floor under oil prices at $100 per barrel. But Saudi King Abdullah and the Emir of Kuwait Ahmed al-Sabah have other foreign policy objectives in mind. “We don’t think there is a need to cut oil production,” said Kuwaiti Oil chief Mohammad al-Olaim on Sept 8th, before he left for an OPEC meeting in Vienna. “If the market requires anything to do, we will. We are not the ones who decided the prices." Ahead of OPEC’s Sept 9th meeting, Riyadh told its customers that oil deliveries to refiners in Europe, the United States and Asia would remain unchanged through October.
Arab Oil Kingdoms Aiming for Election of “Maverick “McCain”
On the eve of the OPEC meeting in Vienna, a senior OPEC source told the al-Hayat newspaper that, “Reducing production, in such conditions, especially before the first quarter of the year, when oil demand increases, would be unjustified.” The OPEC source revealed Riyadh’s price target, “The current price is close to a level that reflects market fundamentals in terms of supply and demand, which indicate levels of $90 to $100 a barrel. OPEC should be cautious and should monitor the market situation closely to prevent a big drop in prices,” he said.
The Arabian monarchs have their eyes on the US political calendar, and are driving oil prices lower in order to help John “Maverick” McCain get elected and become the next commander in chief of the US armed forces in the Persian Gulf. On August 31st, South Carolina Senator Lindsey Graham told the Arab oil kingdoms that Democratic vice-presidential nominee Joe Biden lacked the backbone to stand up to powerful foes or to fix broken governments in the Middle East.
“Biden has national security experience. But experience and judgment need to come together. Biden voted against the first Gulf War to evict Saddam Hussein from Kuwait. He opposed the surge in Iraq. He wants to partition Iraq,” Graham said on ABC News’ This Week. As chairman of the Senate Foreign Relations Committee, Biden opposed the troop buildup and has called for separating Iraq into three autonomous provinces - Shiite, Sunni and Kurd.
Between now and Nov. 4th, the Saudi and Kuwaiti monarchs will attempt to knock US gasoline prices lower, to ease the anxieties of jittery swing voters who are worried about the economy. Soybean and corn prices have also plunged by 30% since early July, in sympathy with lower oil prices, and with a little bit of luck, Americans might also see lower food prices before the November 4th election. Yet only a tiny fraction of Americans will even know why oil and grain prices are tumbling.
Not since the contest between Jimmy Carter and Ronald Reagan in 1980, has expectations of the outcome of a US-presidential election impacted the currency markets in a big-way. In 1980, any signal that Carter was pulling ahead in the polls would send the dollar plummeting in the foreign exchange market. Conversely, Reagan’s landslide victory, by a 51% to 41% margin in the popular tally, and a whopping 489 to 49 in electoral-college votes, set in motion a vigorous four-year bull-run for the US dollar.
In 1980, when Reagan defeated Carter, the British pound lost 10% vs. the dollar after six-months, 22% after one-year and 47% by the end of Reagan’s first term. The “Reagan Revolution” included big tax cuts, and wide swaths of working-class Democrats defected to the Republican Party, which Mr. McCain hopes to attract in the weeks ahead, with his plan to stimulate the US economy by cutting the corporate tax rate 10% to 25%, and extending the Bush tax cuts beyond 2010.
There are several reasons that explain the Euro’s sudden demise, but few traders have noticed that the dollar’s resurrection is mirroring the odds of a McCain victory in November. Futures traders dealing at the on-line parlor Inntrade, based in Dublin, Ireland, have lifted their bids on “Maverick” McCain to a 46% probability of winning the election, up from 30% in mid-July. The perceived shift in “Maverick” McCain’s political fortunes are linked to the latest Gallup poll, putting him 5% ahead of Mr. Obama, due to a huge 15% shift of independent voters and women, now leaning towards Alaskan governor Sarah Palin and the Republican ticket.
Alongside McCain’s jump in the polls, the US-Dollar Index rallied 12% towards the 80-level, gaining support from the emergence of a militaristic Russia, which invaded Georgia and threatened to cut-off energy supplies to Europe. Kremlin kingpin Vladimir Putin has refurbished the US-dollar’s traditional status as a “safe haven” currency. Not since the end of the Cold War has the US-dollar been treated as a “safe-haven” currency in times of dangerous geopolitical turmoil.
Nowadays, the Persian Gulf oil kingdoms regard the possibility of a nuclear armed Iran as a “dire and direct threat” to their own existence, and are flocking to the US-dollar as a safe haven. The sovereign wealth funds (SWF’s) controlled by Dubai, Abu Dhabi, Kuwait and Saudi Arabia have roughly $1.7 trillion between them, dwarfing the largest private equity funds in the world. During the first half of 2008 alone, Saudi Arabia raked in $192 billion from oil exports, just $2 billion less than the kingdom’s total oil export revenues in 2007.
With their enormous size, the Persian Gulf SWF’s can easily move global financial markets. By 2015, the Persian Gulf SWF’s could grow to $5-6 trillion. If Chinese, Russian, and Korean SWF’s are taken into account, the total global SWF value could top $12 trillion, or almost equal to the output of the Euro-zone’s economy. SWF’s are quickly becoming the most powerful investors in the world, and account for 12% of the trading volume in commodities. Their activities will increasingly impact financial markets, and the distribution of strategic resources.
Raging Russian Bear Tarnishes Euro’s Image
Currency traders are wondering just how far Vladimir Putin is prepared to extend Russia’s influence in Asia, Europe and the Middle East. Last month, the Kremlin ordered an invasion of Georgia to prevent it from joining NATO, and its army stands within 50-miles of a new oil pipeline that carries one-million barrels per day of crude oil from the Caspian Sea to the Turkish port of Ceyhan, and jeopardizes Russia’s stranglehold over energy supplies to the European Union.
Armed with $580 billion of foreign reserves (the third largest), Kremlin kingpin Vladimir Putin has become increasing bold, and is willing to use military power to counteract what Moscow considers an unacceptable level of US infringement on its interests in the Middle East and Central Asia. “We are not afraid of anything, including the prospect of a Cold War,” warned President Dmitry Medvedev.
Russia holds the world’s largest natural gas reserves and the eighth-largest oil reserves. It supplies one-quarter of Europe’s oil supply and 30% of its natural gas. In July, deliveries to the Czech Republic through the Druzhba pipeline were cut by 40% after Prague signed an agreement with the US to install an anti-missile shield. The emergence of a militaristic Russia, under former KGB spy master Putin, in alliance with the “Axis of Oil,” has tarnished the Euro’s stellar image, and added an extra degree of risk in investing in European stock markets.
Putin has declared that a new Cold War with the West has already begun and is considering arming Russia’s Baltic fleet with nuclear warheads and pointing them at European cities. “Of course we are returning to those times. It is clear that if a part of the US nuclear capability turns up in Europe, and, in the opinion of our military specialists will threaten us, then we are forced to take corresponding steps in response. The strategic balance in the world is being upset and in order to restore this balance, we will be creating a system of countering that anti-missile system. Naturally, we will have to have new targets in Europe,” Putin warned.
Since Russia invaded Georgia on August 7th, the Kremlin’s foreign exchange reserves have declined by $16.4 billion, the biggest outflow of capital since the country’s financial meltdown in 1998. More than $20 billion is thought to have been withdrawn from Russian stocks by foreign investors, who hold roughly half of all shares outstanding, many listed in London and New York. The Russian central bank was forced to sell US$5 billion in the foreign exchange market to stabilize the Russian rouble, after it tumbled 10% against the resurgent US$, to a one-year low.
While the Kremlin’s coffers have mushroomed, the Russian corporate sector is still heavily reliant on foreign investors. The local bond market is small, with just $60 billion worth of ruble issues. Russian companies borrow funds on the world capital markets, and foreigners own half of the $1 trillion debt. But now Russian companies are facing a liquidity crunch, since foreign lenders are balking and won’t touch any Russian paper. The impact on the Russian stock market has been severe.
The Russian Trading system Index (RTS) was roiled by the exodus of foreign capital, who are on high alert for political risk. Since peaking in May, the Russian stock market has plunged 40%, shaving roughly $500 billion from the value of Russian stocks. Foreigners also dumped large blocks of Russian mining companies after Kremlin kingpin, Putin, accused a large steel and coal mining company, Mechel, MTL.n of tax evasion, causing its share price to collapse. When Putin targets a company, there can be dire consequences, such as the demise of Yukos, a big oil company that was bankrupted on trumped-up tax charges.
Roughly half the RTS Index is comprised of energy related companies, which have also been hard hit by the slide in crude oil prices to $102/barrel. Soaring oil prices were behind Russia’s political and economic resurgence, and help lift the RTS Index by an astounding 720% from six-years ago. But nowadays, the term “Peak Oil” is invoking images of a peak in oil prices and global demand due to a synchronized slide in the global economy, rather than fears that the world is running out of oil.
Most interesting is the observation that the Euro’s slide against the US$ is the near-perfect inverse image of the US-dollar’s climb against the Russian rouble. The emergence of militarist Russia, ready to aim its nukes at Europe, has triggered a flight of capital from the Euro and the Russian rouble, and the US-dollar, backed by the world’s most powerful military, wins by default as a safe haven.
Foreign Exodus from Brazil’s Bovespa, Undermines Brazilian Real
Yet there appears to be more reasons behind the US-dollar’s rally against all major foreign currencies, than just its newly polished image as a “safe-haven” currency. Brazil is not under any threat of military attack from Russia or Iran, and it’s self-sufficient in energy; yet it’s currency, the real, has lost -14% against the US-dollar in recent weeks, even though Brazil’s interest rates are +11% higher.
Foreign investors pulled money out of Brazil’s stock market for a third straight month in August, triggered by the steepest plunge in commodities in five decades. Slumping commodity prices led Sao Paulo’s Bovespa stock index sharply lower, to below the psychological 50,000-level, or 34% off from its May 20th all-time high. More than half of the Bovespa index is made up of natural resources companies and steel mills, whose fate largely hinges on the direction of the global economy.
The Dow Jones Commodity Index has tumbled 27% from a record high set eight weeks ago. Steel prices have plunged 30%, and soybeans are 30% lower. Brazil had posted a trade surplus of $40 billion last year on exports of $160 billion, and strong demand for commodities helped secure a 27% jump in exports from January to July of this year compared to the same period a year ago.
Latin America’s largest economy enjoyed a current account surplus for the last five years; its currency rose to a nine-year high while the central bank stockpiled enough US-dollars to pay off its entire foreign debt and become a net creditor for the first time. But imports are growing at twice the rate of exports this year, due to the super-strong real, and Brazil’s trade surplus plunged 42% in the first half of this year. Now the virtuous cycle is moving in reverse as commodity prices slide and foreigners repatriate their money to avoid losses related to the Bovespa index.
The Brazilian real has plunged 10% in the past 10-days to 1.77, its lowest level against the dollar since February. The performance of Brazil’s currency and stock market, which largely hinge on the direction of commodity markets, actually haven’t differed much from Russia’s. These top-2 emerging markets are leveraged plays on the global economy, and when commodities trend lower, it has a double barreled selling effect on emerging markets. There’s no decoupling from the developed economies of Europe, Japan, and the US, which account for 65% of global GDP.
© 2008 Gary Dorsch