Behind The Curve

By Brady Willett
"Concern about capital flows into the United States have weighed on the dollar, especially as countries such as Canada and New Zealand have already started hiking interest rates in response to a firm pickup in economic growth." Reuters

As absurd as it may sound the Fed would love to be able to start raising interest rates. Why? Because while such an action would certainly startle investors it would also assure them that the 2001 recession was just an aberration - a brief slow down in the worlds most resilient economy.

However, with the 1Q02 economic rebound already displaying signs of weakness the Fed's hands are clearly tied. Moreover, with the U.S. stock markets pricing in a fabulous earnings rebound in the second half of 2002 the Fed could potentially create a financial crisis if they start raising rates before corporate America begins to earn a few bucks.

With this in mind, yesterday may have confirmed many peoples worst fears - or that the dreaded double dip scenario is rearing its ugly head:

"… (the) economy continued to improve but cited concerns that the rate of improvement had slowed considerably from earlier in the year." Beige Book

Granted, the above quote was a reference to Cleveland only, not the entire U.S. economy. Nevertheless, before the gloomy Beige book arrived at 2:00 PM yesterday it was reported that March durable orders dropped by 0.6% and new homes came in weaker than expected. When combining these developments with poor corporate earnings and a fragile labor market, premonitions of a double dip certainly appear to be coming back into focus.

The U.S. Dollar
Dollar dips as "investors reconsidered the once-unrivalled lure of U.S. assets."

It is safe to say that the U.S. dollar is the global currency of choice: when a crisis occurs people don't even think anymore - they simply buy greenbacks.

While it is uncertain when, and if, the illusion surrounding the 'safe haven' qualities of the U.S. dollar will begin to crack, what can be assured is that if the U.S. dollar does fall out of favor this will be the biggest financial development of our lifetimes. Think about: 'As financial crisis strikes investors flock to Euros and/or Yen"??? Not likely…

Consider the winds of change: U.S. assets (stocks) are valued at higher premiums than their global counterparts, the Fed is beginning to fall behind the curve, and gold has not yet been smashed below $300 an ounce.

While I am reluctant to try and predict exactly when the U.S. dollar will capsize, there can be little doubt that the greenback is taking on some water. You may ask why doesn't the Fed throw the drowning dollar a life jacket? Well, such is the deception of 'safe haven' illusion: they already have. Remember, it was the U.S. economy that began to drag down the entire global economy last year (the dollar remained strong). Moreover, remember that during the entire slow down investors were tricked into believing that omnipotent Fed management would ensure that the U.S. economy would be the first economy to sustain a rebound (dollar remains strong). Granted, during the slow-down some people asked 'how can the U.S. be both the source and safe haven of global economic weakness?' However, operative word being 'some' -- not many.

Now that the 'strong dollar' paradox is beginning to be questioned by more people the Fed is slowly running out of answers.


Brady Willett
BWillett@fallstreet.com
www.wallstreetwishlist.com

April 29, 2002