Next Stop: Irene

August 26, 2011

Chairman Bernanke’s predictable speech proved not to be a major market event.  Equities, gold, and bond yields rose afterward in a sign of some relief about future risk.  Consistent with those moves, the dollar fell against the euro, which at 16:50 GMT was hovering just below $1.45 versus a 2011 high so far of $1.4939.  Risk on – risk off trading swings have become a common occurrence with each fresh release of data, and many meaningful indicators are arriving next week.  All of that could be a sideshow, however, if Hurricane Irene creates as much or more damage in the U.S. Northeast as the meteorologists are predicting.

Trading on Monday may feel like a day when the U.S. but not other countries celebrates a holiday.  Transportation infrastructure and electrical power could be knocked out to the U.S. financial capital for that day and beyond.  Often when U.S. markets are shut for holiday, the loss of its trading leadership severely cuts down on volatility.  Dollar/euro closed on Monday July 4, 2011 at 1.4529, four pips from the prior closing on Friday, July 1.  On Memorial Day, Monday May 30, the close of $1.4278 per euro was separated from the previous Friday close of $1.4292 by just 0.1%.  Last Thanksgiving saw the dollar on balance slip 0.4% against the euro.

In a worst case scenario, Hurricane Irene could produce results similar to the 9-11 attack that demolished the World Trade Center almost ten years ago and stopped trading on the stock exchange for several days. Natural disasters diminish economic activity in the short run as shoppers can’t get out to buy and production facilities cannot operate.  Later on, as we’ve seen following Australia’s flood and earthquakes in Japan and New Zealand, reconstruction becomes a stimulant.  Often the transition from the first to the second stage takes longer than hoped or predicted as experienced lately in Australia. 

If Irene hammers business confidence and consumer sentiment and if it revs up talk of a coming U.S. recession, the market conclusions will be 1) for investors to become more risk averse and 2) for speculation to develop that the FOMC could decide to unveil further stimulus as early as its September 20-21st meeting.  The instant response of the dollar could probably be favorable (more risk aversion) or adverse (a shock directed at America), and a danger of whipsaws could develop as other considerations come into play.  The dollar closed 1.7% weaker against the euro on September 11, 2001 than its close on the prior day.  However, for the week of September 10 – 14, the net loss for the U.S. dollar was 1.5%, a tad less than the move on the day of the attack.

Permit me to digress a moment and relate a fascinating coincidence with contemporary timeliness that I discovered when checking the dollar’s price action on the day of the 9-11 attacks.  The biggest news of the day prior to the terrorist act was that S&P had cut the outlook on Japan’s credit rating from stable to negative.  In explanation for the move, S&P said that the policy of the Bank of Japan was not stemming deflation, which increases the real cost of servicing debt, and noted that 60% of all sovereign debt ratings placed on negative outlook are subsequently downgraded after one year.  BOJ Governor Hayami responded to the S&P action, asserting that structural reforms were what Japan needed to end deflation.  The ten-year Japanese Government Bond (JGB) was 1.42% then versus 1.04% now.

At the close on September 10, 2011, the yen was trading at 120.97 per dollar and 108.72 per euro.  Compared to those levels, it has appreciated 57.7% against the dollar and eased 2.2% against the euro.  The main currency movement of these past ten years has not been a strengthening yen or euro but rather a weak dollar, and that theme makes perfect sense in light of the substantial sub-trend growth of U.S. GDP and jobs since the 9-11 attacks.  It’s been a difficult decade for most advanced economies, but in late 2001 the United States and the dollar had the most to lose.

Hurricane Irene offers a two-edged sword for U.S. politicians.  Japanese Prime Minister Kan resigned today, taking responsibility for some mishandling of the earthquake/tsunami/nuclear accident disasters in March.  The 9-11 attacks gave a huge lift to New York Mayor Giuliani’s reputation.  The botched federal role in supporting victims of Hurricane Katrina slammed former President Bush’s standing.  Irene may produce heroes or expose unacceptable incompetence, and it could potentially affect the 2012 elections in ways that will tip the power balance in Washington one way or the other.  This, in turn, may affect the outcome of the evolving struggle over fiscal policy.

There will be plenty of time for analyzing economic data and reacting to the U.S. and European debt difficulties.  For the data-filled week ahead, Hurricane Irene has a chance to play the leading role.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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