HOW DO BANKING REFORMS AFFECT THE DOLLAR?
It has been another active day in the financial markets with the Dow Jones Industrial Average plunging more than 200 points and the dollar moving in vastly different directions against the euro, Japanese Yen and British pound. Despite the lack of consistency in the dollar’s performance, there is one overarching theme in the forex markets today, which is risk aversion. All of the higher yielding currencies have plunged and the only reason why the euro did not participate in the move is because it has already become grossly oversold. Politics have dominated the headlines all week and unfortunately politics can shape economics which is why the dollar had such a sharp reaction to the Republican win in Massachusetts Tuesday night and today’s proposals for banking regulations from President Obama.
How do the Proposed Bank Regulations Really Affect the Dollar?
Based upon the price action in the forex market, it appears that Obama’s proposal to prohibit banks from engaging in proprietary trading, investment or sponsoring of hedge funds as well limiting the growth of liabilities is dollar negative. To some degree this is true and to some degree it is not. In order to understand how the proposed bank regulations will really affect the dollar, we need to first understand what the regulations mean. Fundamentally, all of the proposals are aimed at limiting risk taking by banks. This means that there is will be less speculation in the financial markets which suggests that trends in the forex or other markets may not extend as far as they have in the past. For example, when oil hit a record high, speculation by hedge funds and banks and not a real increase in demand was behind the move. It could also lead to wave of deleveraging if banks are forced to close their proprietary trading desks and unwind their positions. Banks generate a significant amount of money from their proprietary trading operations and therefore their profits may be negatively affected. Of course most banks will find ways to go around the rules and that could involve going private (which Goldman Sachs could do), spin off their prop desks or move offshore. It can also put foreign banks at an advantage from a competiveness and profitability standpoint. Based upon this breakdown, the proposed bank regulations is overwhelming negative for the dollar but also negative for risky assets. If the dollar was a high and not low yielding currency, it would have weakened across the board but since it is a cheap funding currency, the more significant implication would be the need for banks to unwind their risky positions and buy back U.S. dollars. The proposals are just proposals for the time being and it remains to be seen whether it will get through Congress but that has not stopped traders from selling first and asking questions later. Unfortunately Asian traders will probably follow suit this evening.
The Distortion in Jobless Claims
Meanwhile this morning's U.S. economic reports were mixed. The number of people claiming unemployment benefits rose to an 8 month high as jobless claims hit 482k. According to the Labor Department, the jump was due to an "administrative accumulation from late December and early January holidays and did not reflect economic reasons." This suggests that the prior improvement in jobless claims could have also been distorted. The spokesman from the Labor Market said it took extra time for government workers to sort through the applications that were piling up which is definitely not a positive sign for the labor market even if continuing claims improved. Once again, falling unemployment rolls most likely reflects the expiration of unemployment benefits than the accumulation of new jobs. Continuing claims also does not count the number people who are receiving extended benefits under federal programs. This group increased by 613k to 5.92 million in the week ending January 2nd, which is on top of the 4.599k million people counted in the continuing claims report. Unlike manufacturing activity in the NY region, manufacturing activity in Philadelphia slowed this month with the index falling from 22.5 to 15.2. The pace of hiring is still improving but shipments, new orders and average workweek have slowed. There is no question that the pace of the global recovery is moderating and that may be further exacerbated by tighter monetary policy conditions in China. Leading indicators on the other hand rose 1.1 percent, far stronger than market expectations and slightly stronger than the previous month. There are no economic reports due for release from the U.S. tomorrow.
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