Dollar May Move Off Lower Rates

Over the last two weeks U.S. based mortgage rates have dropped from an average 6.8% to 6.1%, the first time this year that they have fallen and held those new levels without suffering the quick reversal that most previous moves lower have seen. "Traders may be able to correlate the mortgage rate with dollar moves over the coming weeks and months" said Jack Jones senior commodity analyst at TheLFB-Forex.com. "The real leg of sustainable dollar moves higher may therefore be seen first in the 15 and 30 year mortgage rates coming down" he added. That move lower may be easier to sustain now that the two largest U.S. based mortgage lenders have U.S. Treasury backing to go about their business in the near-term. The Fannie Mae and Freddie Mac corporations have shed the responsibility to shareholders it seems, and that may allow them to initiate a lending policy that creates market liquidity and generates a new flow of new lines of credit, for those able to qualify under the tighter lending criteria.

"To create economic expansion, or at least to ensure that the current situation does not deteriorate, the Treasury looked to have no real choice but to step into the two entities and bail them out. It is just the same as the Federal Reserve having absolutely no choice at all but to stimulate the consumer, with an example being the Stimulus Checks, albeit a move that the Fed accepts may have a short-lived impact" said Jones. "A sustainable consumer-lead stimulus really can only be achieved by a reduction in mortgage rates, and ideally from the Fed's point of view, via the inter-bank passing along the recent 325 basis point cut in the overnight rate, that up until now has achieved just one thing; the stability of the financial sector" he added. Home owners have seen little, if any, of the rate cuts that were imposed by the Federal Reserve this year, and the spread between overnight lending rates and average mortgage rates currently stands at 4.0%, a huge premium that added to new lending criteria is making it hard for U.S. consumers to pick up the slack in the housing inventory numbers. The move from the Treasury, although maybe forced, could support the recent dollar buying.

If banks start to offer lower mortgage rates, and the U.S. consumer starts to get back into debt, the Fed may be able to move on from the threat of having to cut rates to achieve growth, and concentrate on the four mandates that it was put in power to achieve, they are;

1. Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
2. Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers.
3. Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.
4. Providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system.

"Once the Federal Reserve has those four mandates in place the economy can more easily grow, albeit off ever increasing private and public debt levels that look to have little or no chance of being paid off. The markets will then look forward to the boom part of the boom and bust cycle, and ignore the underlying fundamentals to the greater degree” said Jones. The U.S. is moving the Peak to Trough, back to Peak in its business cycle in about half the time that global regions are moving through theirs, and the reason may be the mountain of debt that does not allow for sustainable expansion without massive doses of overseas debt.

U.S. Debt Mountain It is not going away

The markets are running the dollar on sentiment right now, and seem to be ignoring the fundamental reality of increasing jobless claims, lower income and savings, and ever increasing government and public debt levels, says Terry Crawley a retired institutional bond trader. When the markets are fueled by optimism it does not take too much to set dollar-protection buying into a momentum move that will then feed of itself. The real key to all of this holding is for the U.S. not to print economic releases below the expected number, even if those expected numbers are poor, he says.

"So long as the economic releases are above the expected number, they may be enough to sustain the dollar buying" says Crawley. "With the U.S. economy finding a way to print 'as expected' growth numbers going through to the end of 2008 in GDP (Gross Domestic Product; the value of all goods and services within an economy) and ISM (Institute of Supply Management; the most influential of all non-government related surveys) releases, and at the same time reducing the housing inventory levels from the current eleven months via mortgage rates dropping for the first time this year, it is likely to lead to the dollar continuing to get bought" he says. "As the overseas holders of Usd denominated debt step in to protect their investment from a falling dollar, thoughts then turn to sustainable appreciation in the U.S. currency if other global regions are not pushing forward themselves. If banks start lending and the economy stops contracting, then debt levels become nothing other than a hindrance to be dealt with at some stage in the future." It is something that has been seen time and again, and it is widely accepted now that the U.S. debt mountain is nothing more than a permanent mortgage that will not ever get paid off, says Crawley.

"Until the overseas regions that back the other side of the Usd currency pair show growth, that is how it will stay." Crawley says. "A stronger dollar will impact the U.S. trade balance in a negative way, but that may be off-set by the fact that a sustainable increase in dollar values will start to decrease commodity inflation. The U.S. economy will grow if banks start to lend, both to themselves, to corporations and to the public. Negative thoughts of the reality of U.S. debt will be replaced by market momentum until a central bank overseas shows growth above the expected."

In an explanation of how the U.S. debt mountain can be easily ignored in the near-term, Crawley adds "However much we read, see, and hear of the negative impact of the amount of debt that the U.S. has issued, we have to remember that as much as was issued has actually been bought. Some of it was forced purchases of reserve currency by central banks, and corporations, but a lot was taken as a matter of choice by investors and overseas wealth funds. U.S. debt is viewed as safe, but most of that U.S. debt has been bought at much higher values than the current dollar price. As such most overseas dollar reserves are at a negative local currency/Usd value from where it was initially purchased. It is not unreasonable therefore that those holders of Usd denominated debt to want to keep their reserve values up, or at least protect the downside, whenever the chances arise, and that is done by buying more dollars".

Written by TheLFB Trade Team, © 2007-2008 LFB Services, LLC. All rights reserved. http://www.TheLFB-Forex.com

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