Hope and Change Meet Reality and Continuity

November 12, 2008

President-elect Barack Obama ran on on platform of hope and change. During the first week of the Obama presidency’s 11-week gestation period, these lofty ambitions ran into a wall of economic gloom, continuing asset liquidation, and intensified random violence in the Middle East.  The U.S. October labor report was simply awful. A who’s who of ominous corporate news from General Motors, Alcoa, Circuit City, AIG, DHL, Tyco and various Wall Street giants crossed the ticker. The news was full as well of evidence that the tide of foreclosures continues to rise. Despite continuing progress in de-icing money markets, where three-month deposits fell another 53 basis points, the Dow Jones Industrial Average and Nasdaq plunged 9.7% and 11.1% in the week since November 4th. Oil dived another 15.9% and moved below $60 compared to monthly averages of $76.81 in October, $103.57 in September, $116.69 in August and $133.97 in July. Investors remain unconvinced that new leadership will avert a prolonged and deep recession and seem to be hedging their bets against the possibility that America can regain its former economic preeminence within ten years, if ever. Amid all this, however, the dollar was a clear winner, rising especially against commodity currencies (by 6.2% against the Aussie dollar, 5.7% relative to the kiwi, and 4.9% against the Canadian dollar) but also advancing 3.6% against both sterling and the euro and by 2.0% versus the Swiss franc. Only the yen, which rose 2.2%, did the dollar decline.

In this instance, however, dollar strength does not reflect economic confidence. Because the United States can still borrow from foreigners in its own currency and offers investors comparatively high liquidity, U.S. assets are considered relatively safe, and the dollar thrives on very bad U.S. and global economic news. Like plummeting stocks, dollar appreciation is tantamount to a thumbs-down on economic prospects. Policy options during the next ten weeks will be limited. Without intervention, a good potential exists for the yen to retest its October high of 90.95 per dollar and for the euro to sink to $1.15 or below before Obama takes his oath of office. Many investors will be disappointed if sterling doesn’t perform worse than the euro, and a word of caution is warranted in that particular case. No market behaves more counter-intuitively than foreign exchange. Highly anticipated movements like the drop in sterling that is now being universally predicted seem to happen less often than not.

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