Despite the resurgence of the dollar, Ambrose Evans-Pritchard remains unconvinced that things in the US are now as rosy as the new found (albeit guarded) optimism suggests. He comes by his view without disputing the view that the dollar rally has legs. I’m not very optimistic about that.
Why? A drinking buddy with amazing connections in the international banking community (he and his parters can get Trichet on the phone) has said since January that the dollar would rally because foreign banks, particularly UK and European banks, were in simply dreadful shape, which in turn meant their economies would wind up in recession. Once the markets figured that out, the dollar would have a nice run. But he has been equally adamant that the dollar is a long-term sell because we will be unable to dig our way out of our trade deficits.
And there are plenty of other shoes about to drop. Chris Whalen of Institutional Risk Analytics has warned for some time of a second leg down in the credit crunch as regional banks take writedowns. The Financial Times today warns that “US banks scramble to refinance maturing debt“:
Battered US financial groups will have to refinance billions of dollars in maturing debt over the coming months, a move likely to push banks’ funding costs higher and curb their profitability, say bankers and analysts…
The rising funding costs are set to put pressure on earnings because, in many of their businesses, banks rely on the difference between borrowing and lending rates to make money.
“It is difficult to see how banks will continue to repeat the heady profit growth of the past few years if they borrow at these levels,” said a Wall Street banker.
Banks could also be forced to raise lending rates, exacerbating the credit crunch felt by many businesses and individuals and further depressing economic activity.
Mohamed El-Erian, co-chief executive of Pimco, the asset management group, said: “If banks keep borrowing at these levels, you will get a repricing of credit for the whole economy.”
And if they don’t borrow at the same level, they shrink their balance sheets, which is also contraction-making.
From the Telegraph:
Two alerts landed on my desk this weekend from the elite markets team at Goldman Sachs. One was entitled “The Dollar Has Bottomed!”….
The other note advised clients to “Take Profit on Globalization Basket”, especially on Eastern Europe currencies. Goldman Sachs has quietly dropped its talk of $200 oil. Even Russia’s petro-rouble is now deemed suspect.
The twin missives more or less sum up the dramatic change in mood sweeping financial markets since it became evident that the entire bloc of rich OECD countries has succumbed to the delayed effects of the credit crisis.
Japan contracted by 0.6pc in the second quarter, Germany by 0.5pc, France and Italy by 0.3pc. Spain recalled the cabinet last week for an emergency summit. New Zealand and Denmark are in recession. Iceland contracted at a catastrophic 3.7pc in the second quarter.
“The whole decoupling thesis has started to come apart at the seams,” said David Bloom, currency chief at HSBC….
Yves here. Note the Nouriel Roubini from the get-go deemed decoupling to be bunk.
The UK economy is not my brief, but I see that hedge funds are circulating a report from the US guru Jeremy Grantham predicting a very bad end to Gordon Brown’s debt experiment.
“The UK housing event is probably second only to the Japanese 1990 land bubble in the Real Estate Bubble Hall of Fame. UK house prices could easily decline 50pc from the peak, and at that lower level they would still be higher than they were in 1997 as a multiple of income,” he said.
“If prices go all the way back to trend, and history says that is extremely likely, then the UK financial system will need some serious bail-outs and the global ripples will be substantial.”
For months the exchange markets ignored this impending train crash, just as they ignored the property bust in Europe’s Latin Bloc, or the little detail that UBS alone had just lost the equivalent of 8pc of Switzerland’s GDP. All they cared about in the currency pits was the interest rate gap: US low, Europe high.
Now the paradigm has flipped. The Fed may have been right after all to slash rates to 2pc. The European Central Bank may have panicked by tightening in July. Note that the elder Swiss National Bank did not do anything so rash.
Bulls now believe America is turning the corner. Financial stocks are up 20pc since early July. Some “monoline” bond insurers have risen 1,200pc in a month as fears of Götterdämmerung give way to sheer intoxicating relief, and a “short-squeeze”. Such are bear-trap rallies.
Regrettably, I remain beset by gloom. The US fiscal stimulus package that kept spending afloat in the second quarter is running out fast. There is nothing yet to replace it. The export boom cannot keep adding juice as the global crunch hits. My fear is that the US will tip into a second, deeper leg of the downturn, setting off a wave of savage job cuts. This will start to feel more like a real depression.
The futures market is pricing a 33pc fall in US house prices from peak to trough, based on the Case-Shiller index. Banks have not come close to writing off implied losses on this scale.
Daniel Alpert from Westwood Capital predicts that a mere 28pc fall would alone lead to a $5.4 trillion haircut in US household wealth, and leave lenders nursing $1.25 trillion in losses. So far they have confessed to less than $500bn.
Meredith Whitney, the Oppenheimer’s bank Cassandra, predicts a gruesome 40pc fall in prices. If so, expect prime borrowers facing negative equity to start throwing in the towel en masse. “I do not think we are near the end of writedowns. I continue to see capital levels going lower, and stocks going lower,” she said.
So no, this painful ordeal is far from over. We are not witnessing a dollar rally so much as a collapse in European and commodity currencies. The race to the bottom has begun in earnest.
It would be better if I were proven wrong, but Whitney’s estimate give me some solace. At the Inman Real Estate conference in San Francisco last month, I said that the peak to trough fall in housing prices would be between 35% and 40%.