Imploding Economy Boosts The Dollar

The writing seems to have been on the wall. The bailout of AIG could lead to the belief that bad corporate performance by AIG was on the cards. AIG’s largest ever declaration of a quarterly loss in corporate history seems to have triggered a massive sell of stocks across America and Asia. The Dow lost nearly 300 points and touched lowest levels since 1997. AIG only seems to have acted as a trigger point for something that appears to have been waiting to happen. Shrinking economies, job losses and the deepening sense of gloom seems to have triggered the sell off, enhancing risk aversion and propping the US dollar. Another trigger for the sell off could have been Warren Buffet’s declaration of his company’s performance being worst ever in 2008, and his projection that the economic mess may extend beyond 2009.

However, experts believe that the stock markets are yet to reach their nadir. The market bottoming is usually characterized by panic selling in large volumes. This phenomenon is yet to occur and so the market bottom may yet be some time away. However, it can be speculated that the market nadir may be close as some indicators suggest that the real economy may be close to bottoming out.  The US economy, which contracted at the rate of 6.2% in the fourth quarter of 2008, is likely to shrink by 5% in the first quarter of 2009. US manufacturing contracted at a slower pace in February compared to January. The uncertain economic scenario has led to the US saving rate jump up to 5% in January opposed to the negative savings rate in the last few years. At the same time consumer spending rose marginally in January by 0.6% after recording negative growth for six straight months. The reason for the increase in spending and savings can probably be attributed to the rise in personal income of 0.4% on the back of pay hikes for government employees. While these may be indicative of the worst being over, it may just be a bit too early to safely assume that.

The worsening economic woes led to investors taking shelter in the safety of US government bonds, leading to the US dollar to firm up. Major world currencies dipped against the US dollar due to a sellout on various stock markets and the money finding its way into US government paper. Stocks fell over 5% in Brazil and 4.6% in Mexico and the drop in indexes in Europe mirrored the trend, with a 5.3% fall in the UK and 4.5% in France early this week. Asian stocks fell across territories including Japan, China and India. The flight of capital from these stock markets is depressing local currency values to all time lows, with the Indian rupee touching a lifetime low of Rs 51.92 to the US dollar.  The emerging risk aversion sentiment has not even spared growing economies like that of Australia, which is expected to have expanded 1.2% in 2008. The Australian dollar weakened against the US dollar in spite of the nation’s central bank leaving interest rates unchanged. It may be noted that economies of China and India are on a strong growth path of over 5% per annum, however their currencies continue to weaken. Thus it appears that it is sentiment that is driving the US dollar’s strength versus all major currencies irrespective of economic fundamentals belying those currencies. This seems to be dangerous climb for the US dollar, with a nation with weakened economic fundamentals being entrusted with the task of keeping global investments secure in the form of US government treasuries!

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