OBAMA AND THE CURRENCY MARKETS
Barack Obama’s constituencies in the US trade unions and Detroit automakers may lead to a more hawkish rhetoric against China endangering the export potential of the Middle Kingdom

By Matein Khalid

Economics helped put Barack Obama in the White House and economics will obsess the next White House. The 900 point drop in the Dow Jones in the two days after the election was a vivid symbol of the macroeconomic malaise that afflicts America. The US recession that began last spring is deepening. The jobless rate could well be headed to eight per cent, the Detroit auto colossi could well not survive the next 100 days as the chairman of GM Richard Wagoner hinted. The ISM collapse shows that the consumer recession has now broadened to manufacturing. While home prices are no longer in free fall, homeowners have been traumatised by the wealth effect and have now begun to slash their credit card debts.

Gloom ahead
The plunge in retail sales, auto sales and University of Michigan consumer confidence index all prove conclusively that the global consumer faces his worst downturn since the Reagan slump of the early 1990s. The Bernanke Fed and the US Treasury have managed to unthaw the frozen money markets, with three month LIBOR (London Interbank Overnight Rate) now down to 2.3 per cent, 250 basis points below the October peak of 4.82 per cent. Three month LIBOR is now at its lowest since the failure of Lehman Brothers. The unfrozen money markets and Obama’s election also means that the dollar’s frantic rise against the Euro and Asian currencies may now decelerate.

Fiscal stimulus, the traditional Democratic calls for a weak dollar, a trillion dollar budget deficit swelled by bailouts of Wall Street banks and (potentially) Detroit, a Fed funds rate of only one per cent and grim macro data (ISM, retail sales, Chicago PMI, payrolls) all would argue for a lower dollar.

Political fallout
Obama’s constituencies in the US trade unions, the Midwest and Detroit automakers could also demand a hawkish, even protectionist rhetoric against China, whose yuan policy has anchored its phenomenal export growth. Obama has publicly branded China a currency manipulator and unlike Paulson, could well cause the Chinese to appreciate the yuan against the dollar.

Financial distress is palpable in China’s Guangdong province, the export epicenter of the Middle Kingdom. Thousands of export sweatshop factories face closure. Chinese GDP growth is slowing down and the threat of protectionist legislation in a Democratic Congress could limit the ability of the Politburo to slow down the pace of yuan appreciation at the precise moment Chinese exporters can least afford it.

While the Chinese yuan has appreciated more than 20 per cent against the dollar since it abandoned the peg in July 2005, its next trend could be a 5-8 per cent depreciation as its trade surplus shrinks, exports plummet in the global market and the protectionist decibel count rises in Washington. The Bank of England’s 150 basis point rate cut shocked the currency markets and reflects the UK’s swift decent into recession. The macro disaster from the housing free fall, nationalisation of Royal Bank of Scotland and HBOS Plc and the freeze in bank credit, job losses in the city of London can only prove bearish for sterling and the Euro. Even the collapse of sterling against the dollar has not really helped UK exporters as global demand softens.

With oil prices at $60, sterling’s role as a haven to recycle Arab petrodollars is also over and there is no high yield argument for sterling reserves for Arab central banks now that the base rate is three per cent. I believe that we have not bottomed on sterling, that the High Street banks (including Barclays) will need to raise more capital, that Britain’s GDP contraction will be worse than the Eurozone or the US. So I expect sterling to fall even more against the dollar to 1.48 and against the Euro to 0.85.

I am also negative on the Canadian dollar, which benefited disproportionately from investment flows in Canada’s Alberta tar sands and the gold, commodities stocks listed on the Toronto and Vancouver exchanges. However, at $57 Brent, the Canadian tar sands are uneconomic.

Moreover, Canadian exports to the US which are dominated by auto parts and forestry products, will be decimated by the woes of Detroit and the homebuilders. The GM chairman even warned that the next 100 days could see a bankruptcy filing without a bailout from Washington. The bear markets in commodities will be protracted, as both China and Indian GDP growth softens. The Canadian dollar could well fall to 1.25 against the greenback in the next quarter.

The author is a renowned investment banker based in Dubai

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