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Today's Market WrapUp  09.09.2008  Mon  Tue  Wed  Thu  Fri  Dorsch Archive
"Maverick McCain" and the Resurrection of the US$
“As soon as you think you’ve got the key to the stock market, they change the lock,” lamented Joe Granville, who is mostly remembered for his bearish calls on the US stock market during the 1970’s, 1980’s, and the 1990’s. Nowadays, many currency traders are scratching their heads, trying to figure out what’s behind the sudden resurrection of the US-dollar, which has been flexing its muscles, and bucking conventional logic by climbing sharply higher against all major foreign currencies, including those that offer much higher rates of interest.
The Euro has plummeted 12% vs. the US-dollar tumbling to as low as $1.410 today. Euro-zone Finance chief Jean-Claude Juncker was happy to give currency traders the green-light to trash the Euro this week. “Things are developing in the right direction, in line with the commitments of the US Treasury that it stated in recent months. The Euro is less than $1.44, and it reflects economic fundamentals better than the Euro flirting with $1.60. I still think that the Euro is overvalued, not only against the dollar, but also against other currencies,” he said.
There’s been a major shift in market psychology surrounding the US-dollar that’s caught many currency traders by surprise. Until July 15th, the key driver fueling the Euro’s historic advance against the US$ was a widening interest rate advantage. In Frankfurt, Germany’s 2-year yield rose to as high as +220 basis points above the comparable US-T-note in June, and up sharply from a negative -80 basis points in April 2007, which in turn guided the Euro on a steady climb higher to $1.600.
Even a rash of US bank failures and the possible collapse of Lehman Brothers, LEH, Wall’s Street’s fourth biggest investment bank, a big player in the sub-prime mortgage market, hasn’t put a dent in the US-dollar’s newly minted Teflon armor. Lehman’s 8% preferred-J shares plummeted today to $8 per share, lifting its junk-status yield to 25%, after an eleventh-hour rescue attempt by the Korea Development Bank (KDB) was placed in doubt.
True to form, the credit rating agencies are still touting LEH’s credit status at single “A” even though the company is locked out of the credit markets. And where there is smoke, there is fire! The cost of protecting Lehman's debt with credit default swaps for five-years rose to 450 basis points, or $450,000 a year to protect $10 million of debt, up from 325 basis points the previous day. When a bank loses the confidence of its customers, it can evaporate very quickly, just like Bear Stearns.
Less than 48-hours earlier, the US government seized mortgage giants Fannie Mae and Freddie Mac, a move that could potentially cost US taxpayers $200 billion. The US economy lost 84,000 jobs in August, and has shed jobs for eight straight months, something that has happened only eight other times since the end of the World War Two. In each instance, the string of job losses signaled a recession.
Arab Oil Kingdoms Flock to US-Dollar
Yet despite all this bearish news for the US-dollar, currency traders are putting a positive spin on whatever mud can be thrown at the greenback. What’s behind this sea-change in market psychology towards the US-dollar, where the focus has shifted away from interest rate differentials, and instead, has veered-off towards other key factors? They were highlighted in the August editions of Global Money Trends.
Throughout the US-dollar’s tortuous 40% slide over the past six-years, the Arab oil kingdoms in the Persian Gulf stayed loyal to their archaic US-dollar pegs, even while the Fed’s indifference to the sliding US-dollar sent inflation shock waves through their dollar-linked economies. The Arab oil kingdoms rescued the US-dollar from the brink of collapse by rapidly expanding the supply of Kuwait dinars and Saudi riyals, and recycled about $250 billion of Petro-dollars into US Treasuries over the past 12-months through their brokers in London.
Saudi Arabia’s M3 money supply is 21% higher from a year ago, fueling inflation to +11.1% in July, it’s highest in 30-years. In Abu Dhabi, the biggest member of the UAE federation, prices were 12.9% higher in June. In return, the US armed forces defend the Arab Oil kingdoms from their dangerous neighbors to the north in Iran, which seeks nuclear weapons, and is closely aligned with czarist Russia, and Venezuela’s mercurial kingpin Hugo Chavez, forming the “Axis of Oil.”
The recycling of Arabian Petro-dollars into US Treasuries put a floor under the US$ Index at the 70-level this summer, and persuaded bearish currency traders to cover massive short positions that had been built-up in the US$ over the past six-years. King Abdullah of Saudi Arabia upped the ante by boosting the kingdom’s oil output by 1.1 million barrels per day (bpd) from a year-ago to a record 9.7 million in July, which has deflated the crude oil bubble by a whopping $45 barrel so far.
On Sept 8th, OPEC chief Chakib Khelil said he expected the oil market to be oversupplied at the end of this year. “There is plenty of oil in the market, stocks are pretty good. There will be an oversupply of one-million bpd by early next year,” he predicted. Khelil also noted that oil prices were easing as the value of dollar rose. US crude fell to under $102 as the dollar hit an 11-month high against the Euro. “What we are seeing now is the inverse relationship between the US dollar and the oil price is verified. The dollar is strengthening, the oil price is going down,” he added.
The Arabian monarchs have their eyes on the US political calendar, and are driving oil prices lower in order to help John “Maverick” McCain get elected and become the next commander in chief of the US armed forces in the Persian Gulf. On August 31st, South Carolina Senator Lindsey Graham told the Arab oil kingdoms that Democratic vice-presidential nominee Joe Biden lacked the backbone to stand up to powerful foes or to fix broken governments in the Middle East.
“Biden has national security experience. But experience and judgment need to come together. Biden voted against the first Gulf War to evict Saddam Hussein from Kuwait. He opposed the surge in Iraq. He wants to partition Iraq,” Graham said on ABC News’ This Week. As chairman of the Senate Foreign Relations Committee, Biden opposed the troop buildup and has called for separating Iraq into three autonomous provinces - Shiite, Sunni and Kurd.
Between now and Nov. 4th, the Saudi and Kuwaiti monarchs will attempt to knock US gasoline prices lower, to ease the anxieties of jittery swing voters who are worried about the economy. Soybean and corn prices have also plunged by 30% since early July, in sympathy with lower oil prices, and with a little bit of luck, Americans might also see lower food prices before the November 4th election. Yet only a tiny fraction of Americans will even know why oil and grain prices are tumbling.
There are several reasons that explain the Euro’s sudden demise, but few traders have noticed that the dollar’s resurrection is mirroring the odds of a McCain victory in November. Futures traders dealing at the on-line parlor Inntrade, based in Dublin, Ireland, have lifted their bids on “Maverick” McCain to a 46% probability of winning the election, up from 30% in mid-July. The perceived shift in “Maverick” McCain’s political fortunes are linked to the latest Gallup poll, putting him 5% ahead of Mr. Obama, due to a huge 15% shift of independent voters and women, now leaning towards Alaskan governor Sarah Palin and the Republican ticket.
Alongside McCain’s jump in the polls, the US-Dollar Index rallied 12% towards the 80-level, gaining support from the emergence of a militaristic Russia, which invaded Georgia and threatened to cut-off energy supplies to Europe. Kremlin kingpin Vladimir Putin has refurbished the US-dollar’s traditional status as a “safe haven” currency. Not since the end of the Cold War has the US-dollar been treated as a “safe-haven” currency in times of dangerous geopolitical turmoil.
Nowadays, the Persian Gulf oil kingdoms regard the possibility of a nuclear armed Iran as a “dire and direct threat” to their own existence, and are flocking to the US-dollar as a safe haven. The sovereign wealth funds (SWF’s) controlled by Dubai, Abu Dhabi, Kuwait and Saudi Arabia have roughly $1.7 trillion between them, dwarfing the largest private equity funds in the world. During the first half of 2008 alone, Saudi Arabia raked in $192 billion from oil exports, just $2 billion less than the kingdom’s total oil export revenues in 2007.
With their enormous size, the Persian Gulf SWF’s can easily move global financial markets. By 2015, the Persian Gulf SWF’s could grow to $5-6 trillion. If Chinese, Russian, and Korean SWF’s are taken into account, the total global SWF value could top $12 trillion, or almost equal to the output of the Euro-zone’s economy. SWF’s are quickly becoming the most powerful investors in the world, and account for 12% of the trading volume in commodities. Their activities will increasingly impact financial markets, and the distribution of strategic resources.