Economic Indicators

After a brief hiatus, the Australian Dollar has resumed its upward march against the Dollar; its next milestone will be a 25-year high against the Greenback. Of course, its continued strength is due to a combination of high domestic interest rates and high commodity prices. In fact, its performance seems to mirror the price of gold, which is no coincidence since gold may be Australia's most valuable export. In addition, gold has value as a monetary instrument, which means an appreciation in gold can give the Australian Dollar a double-boost by lifting it while simultaneously punishing the US Dollar. With regard its domestic monetary policy, Australian inflation recently passed the 4% mark, which means interest rates (already at 7.25%) are likely to stay high for a while.

Who's familiar with the "song that never ends?" How about the credit crisis that never ends?

The narrative in forex markets had recently become so cut-and-dried, that investors may have forgotten that in the long-term, a variety of factors weigh on currencies. Last week, they were sternly reminded of this fact when tensions in the Middle East boiled over and sent the Dollar racing downwards. An Iranian missile launch sparked the initial uproar, but was quickly followed by unrelated violence in Turkey and Iraq. First, the price of oil skyrocketed, and then the Dollar fell, consistent with the inverse correlation which has been observed between the two commodities. It is unlikely that geopolitical tensions will supercede the macroeconomic situation; investors continue to monitor the credit crisis and interest rate differentials with vigilance.

When one hears the phrase "housing crisis" uttered, the US immediately comes to mind. Not without reason, of course, since the US housing market is the largest in the world, and the scope of any US housing crisis is sure to dwarf a comparable crisis in any other country, in absolute terms. At the same time, let's not forget that prices in the UK, for example, began to decline earlier than in the US. In addition, as one columnist points out, the impact of the UK housing crisis may be relatively greater on the UK economy. While some of the statistics he quotes are dubious, housing and consumer debt (on a per capita basis)  may in fact be larger in the UK than in the US.

Global capital markets remain caught in a tug of war between inflation and economic growth. For most of 2008, the economic growth story prevailed as the Federal Reserve Bank cut interest rates aggressively to cushion the blow from the housing crisis. However, the pendulum soon swung to inflation and the Fed began to worry that perhaps it had lowered rates too far and may in fact need to hike them in response to surging food and fuel prices. In fact, the European Central Bank recently hiked its benchmark interest rates. Now, a slew of negative economic data threatens to shift the rhetoric back to the other corner. Securities and currencies have fluctuated wildly over this period, and investors remain unsure about which side the world's Central Banks will err on.

The Indian Rupee has fallen to a 14-month low as a result of the sagging Indian stock market and surging inflation. Foreign investors have withdrawn $5.7 Billion from the Indian stock market in the first half of 2008, reinforcing the 30% drop in stock prices that occurred over the same time period. Meanwhile, the nation's benchmark inflation rate has risen to the highest level in nearly 13 years, and investors are clamoring for the Royal Bank of India to do more. The RBI has already raised interest rates as well as intervening on the Rupee's behalf in forex markets, as indicated by data on the RBI's foreign exchange reserves. Both moves were explicitly aimed at combating inflation, but may also carry the unavoidable consequence of stunted economic growth.

Forex analysts reckon the two most powerful forces weighing on the Dollar are commodity prices and European prices, so-to-speak. With regard to commodity prices, it seems plausible that rising commodity prices have contributed to a weaker Dollar, as much as vice versa. Thus, when Saudi Arabia announced recently that it would increase oil production, the Dollar received a nice boost. Conversely, European prices, or inflation, are important for traders to monitor because they represent a proxy for the future of EU monetary policy. Specifically, Eurozone inflation just touched another high, at 3.7%, which analysts point out is now 1.7% higher than the ECB's stated comfort zone.

In the near future, this day may be looked back on as important in the battle between the Dollar and Euro that is currently being waged. The previous month had been relatively kind to the Dollar, which had gradually clawed its way back from a record low against the Euro. Then came yesterday, when Jean-Claude Trichet, leader of the European Central Bank, surprised investors when he announced that not only will the ECB not be cutting rates, but in fact, it may hike them. If enough members of the Central Bank become convinced that inflation is unlikely to abate, the rate hike could come as soon as next month. Today, the knockout punch was delivered, when the US unemployment rate came in at 5.5%.

According to one index, commodity prices have risen 40% over the last twelve months. One would therefore expect the Canadian economy to be commensurately strong. According to the most current economic data, however, just the opposite is true. Wholesale manufacturing sales are down for the second straight quarter. Non-commodity exports are also trending downwards due to sustained economic weakness in the US, Canada's most important trade partner. Continued strength in the Canadian Dollar is also to blame. In addition, Canadians are traveling abroad in greater numbers, while international visitors to Canada have dwindled to record lows. As a result, Canadian GDP is expected to fall close to 0% for the second quarter, significantly below the Central Bank's goal of 1%.

While the credit crisis has ravaged the economies of the US and the UK, the EU has largely been spared. First quarter GDP grew at a healthy annualized rate of 2.8%, helped by a whopping 6% expansion in Germany. However, a number of economic indicators now suggest that all is not well on the European front. Business and consumer confidence indexes are trending downward. Manufacturing output is down. So are retail sales. Spain, which benefited the most during the credit boom, is now reaping the greatest losses during the crunch, and could put a drag on the entire Euro-zone. One prominent economist is predicting that the EU economy won't expand at all in the second quarter.