US Dollar to continue its Decline

With all of the swings in the currency markets, today Faros issued a Special Report to its clients letting them know that they should expect further weakness in the US dollar.  “Given some members of the US Federal Reserve have recently turned up the volume on their desire to end QE2, we want to note just how disastrous higher rates in the US would be.”

  

Employment

The US unemployment rate is currently at 8.5%.  Within non-farm payrolls, 14% of the number comes from the public sector.  With fiscal concerns being addressed through aggressive budget cuts we expect a significant trimming of public sector employees through 2011.  We believe that any gains in private sector payrolls will be overwhelmed by a drop in public sector payrolls, resulting in the unemployment rate rising through 2011.  We note that the USDA recorded a new record for food stamp issuance in January, stating that 14% of the US population (44.2 million) now receives food stamps, up from around 26 million in 2008.  In addition we note that in 2008, 63% of the US Population over 16 was employed.  That number is now around 58%... Translating into a loss of around 15.5 million jobs since 2008.  Neither the food stamp numbers nor the drop in the employed population show any signs of bottoming.

Housing

Despite low interest rates, both new and existing home sales continue to fall.  This is for a number of reasons.  The market is well aware of the foreclosure overhang in the market and recent reports suggest that 27% of homes in the US are now underwater (the homeowner owes more on their home than it is worth).  Banks are holding onto significant foreclosure reserves, and either are unwilling to sell them as they look for better market conditions, or else they cannot sell them because the paperwork is not in order.  In January 37% of all home sales were foreclosures.  Without foreclosure inventory selling in the market the market will remain offered.  Another reason for a lack of turnaround in the housing sector is the fact that it remains very hard for the average person to gain a mortgage without dropping a significant down-payment.  In 2006 the median down-payment was 6%.  It is now 22%.  For this reason, according to the National Association of Realtors, 33% of existing home sales are all cash transactions.

While higher rates may combat higher inflation, they will do nothing to support employment or housing.  Both remain on a negative trend with little sign of 'green shoots'.  We believe that rates will be kept low for an extended period and dismiss talk of rate rises in 2011.  This will support a weaker USD as 'priced-in' rate rises in the short-end of the US curve collapse.  Meanwhile Central Banks around the world are raising rates in line with higher prices.  The way forward for the US is through a weaker USD.  In part to fulfill the Obama administration's wish to double US exports over the next 5 years, and also so as to spur asset inflation in the housing markets so as to clear foreclosure inventory.  While higher inflation is knocking on the door we think it unlikely the Fed will act upon it, indeed we feel it is more likely they will act to keep rates low, and that means through QE3 or other non-traditional measures.

The 2-year swap differential between the US and Europe is now at 146 basis points.   We continue to expect this will rise to over 150 basis points, leading the EUR/USD to rise over 1.5000 and beyond in the next few months. 

Source