Hang on just a second. Are those "green shoots" popping up through the ground? Or, as Nouriel Roubini told CNBC, are they "yellow weeds"? Is the recovery begun? Or were the least six weeks an exercise in optimism for its own sake?
The Australian market gets to return its verdict on the issue this week. It will have mixed evidence to consider. In the U.S., last week's April retail sales figures showed the second consecutive monthly decline. Credit card defaults rose to record rates in April, according to CNBC, with both Citigroup and Wells Fargo having double digit charge-off rates.
That data would seem to put paid to the theory that the U.S. consumer is recovering his nerve and his will (or ability) to spend. The U.S. economy has shed over two million jobs this year. It's hard to see how the American consumer is going to charge his way through this mess and lead the world to a new prosperity.
What about our friends in Europe? Reports last week showed that the Eurozone's economy shrank by 2.5% in the first quarter. Germany-the industrial engine of European output-saw its output fall by 3.8% in the quarter. Granted, this is not as bad as the collapse in Japanese production and exports. But such a large slow-down in the Eurozone was enough to take two dollars out of the oil price.
By the way, we still think oil will rally because of big structural problems on the supply side. It will be worth watching. If oil keeps creeping up despite the litany of negative news about economic growth, you'll know the thesis is valid.
What will investors do if the "green shoots" idea withers this week? Well, they may do what they did in February. Remember that? As heaps of negative economic data poured in, investors drove gold and U.S. Treasuries up and virtually everything else down.
We remember it because it was so weird. The rally in the U.S. dollar came at a point of maximum pessimism about U.S. deficits. But as there was maximum pessimism about the global economy at the same time, you got a "flight to safety" bid for the dollar and gold. Strange bedfellows for a rally, don't you think?
It's hard to say where the local market could find support. If it follows the overseas lead, down it goes. But we reckon a few people will focus on the affordability report out today from the Housing Industry Association. The view that housing is Australia's great wealth defence against recession and a bear market is incredibly strong. Will today's report contradict that view? Probably not.
Nearly everyone is happy that the first home buyer's grant has propped up the market during the worst (so far) of the recession. We say "nearly everyone." Kevin Sherman, the managing director of lender MyRate, says first home buyers who've taken the grant had better be careful.
"Unfortunately," he says, "the grant is artificially inflating prices at the lower end and could have dire consequences for the future...It's important to take stock and ask yourself if you are already stretched in your repayments. You don't want to be one of the first-home owners to be affected because there is a possibility these inflated prices will fall and rates will go up during the term of your loan."
Yes. Interest rates go up as well as they go down.
Here is a bit of a riddler. The U.S. Dollar index is on the verge of a breakout. But in which direction?
The chart below shows the performance of the dollar index over the last 36 months. The red line is the 200-day moving average. And late last week, the index dipped below that (a bearish signal). But the blue line is the 50-day moving average. And typically, when the short-term moving average crosses above the long-term, it's a sign of bullish momentum. So which way is the greenback headed?
Dollar Index Reaches Fork in the Road
As the great Yogi Berra once said, "When you come to a fork in the road, take it."
The action on the dollar index will have a lot to say about the Aussie dollar, gold, and oil. For example, the Aussie dollar fell 2.1% last week against the USD. That was the currency's first weekly loss against the greenback since February. It's probably not a coincidence that it happened the same week the Australian government said the country would run a budget deficit until 2015-2016.
The Aussie gold price moved up two percent on Friday as the currency fell. The U.S. dollar gold price looks steady at about US$930/oz. As you can see, the Aussie price moved up A$24.95 to $1,242.47.
By the way, we think this shows that even as one currency weakens relative to another, BOTH can weaken relative to gold. This happens when governments choose to run large fiscal deficits. It strengthens the case for gold and lessens the appeal of interest-rate driven carry trades.
However, the Aussie gold price has some work to do if it's going to re-test the high it made earlier this year at $1,546/oz. The big driver of that move was the plunge in the exchange rate versus the U.S. dollar. Could that happen again?
Aussie Gold Price up 123% Over Last Five Years
It COULD happen. That is, another manic episode of Depression worries could send markets down from their recent highs. The "let's-take-some-risks-with-borrowed-money-because-everything-is-gettin-better" rally would end and a counter-rally in gold and U.S. Treasuries might begin again. This would mean death to the "green shoots" thesis. It would also mean investors have to reconsider the idea that the worst of this recession is behind us.
Here is something to consider. Maybe this pause in the certainty of the recovery will lead to even more aggressive monetary and fiscal expansion by central bankers and governments. Former Fed Vice Chairman Alan Blinder looked like he was setting the stage for that action in a weekend piece for the New York Times.
Blinder wrote that the recovery in U.S. GDP from 1933 to 1936 was cut short by premature concern about inflation and rising deficits. Imagine that. A former Fed official saying not to be overly worried about inflation and deficits, or you risk another Great Depression!
"In the summer of 1936," Blinder writes, "the Fed looked at the large volume of excess reserves piled up in the banking system, concluded that this mountain of liquidity could be fodder for future inflation, and began to withdraw it. ...About the same time, President Roosevelt looked at what seemed to be enormous federal budget deficits, concluded that it was time to put the nation's fiscal house in order and started raising taxes and reducing spending."
"Thus, both monetary and fiscal policies did an abrupt about-face in 1936 and 1937, and the consequences were as predictable as they were tragic. The United States economy, which had been rapidly climbing out of the cellar from 1933 to 1936, was kicked rudely down the stairs again."
The U.S. and world economies haven't even stopped falling yet, much less hit the cellar. The rate of decline has slowed. But the scary thought here is that policy makers are in no hurry to reverse policies that have led to large deficits and a massive build up in bank reserves. This leads us to believe that the coming inflation-when it comes-will be much worse than it has to be. But some people just can't leave well enough alone and let the recession correct the excesses of the previous credit boom.
Who knows what people will think and why they think it? All we know as the week begins is that the markets are definitely at a fork in the road. A bearish fork for Aussie equities is probably good for the Aussie gold price, but tells us the economic situation is getting worse. A bullish fork? More on that road tomorrow.
Meanwhile, the latest jobless numbers are higher than forecast.
Dan Denning
for The Daily Reckoning Australia
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- The Aussie Dollar as a Measure of Global Risk Appetite
About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Gerald on 18 May 2009:
Re the credit card defaults, almost more importantly you should check the blogs of all the better credit risk people in the US who have had their credit limits chopped of at the kneecap or below their current balances, putting them over limit with associated penalties, without a letter. This one act will decimate the economy as these small business people function on a day to day basis with these "credit lines" to keep gears turning. The joys of a "no limit" amex until you are thousands of mile from home closing a quick deal only to find you can't fund the purchase. peachy recession buster!