Forex Investment and Currency Trading

Economic reports over recent weeks, particularly the third consecutive fall in payroll employment in March, have increased the probability that the US economy is in recession, a view shared (personally) by Martin Feldstein, chair of the NBER business cycle committee, who suggested the downturn may have begun in January. While there are hopes that the forward-looking tax rebate program enacted earlier this year and set to distribute about $65-70bn in rebates to US taxpayers later this quarter will help shortcircuit the downturn, that stimulus may be wiped out by the ongoing surge in gasoline prices. During 2H 2007 the average price of regular gasoline was about $2.90. The price is currently $3.34 and the ongoing rise in crude oil and wholesale gasoline prices has led the US Energy Information Administration to forecast that the average price of gas will reach $3.60 this summer. Given that each 10¢ rise in the gasoline price drains about $12bn (annualized) from US gasoline consumers, a $3.40 average price this quarter would essentially drain consumers of much of the benefit of the tax rebates, sharply limiting its stimulative effect. In this context, it appears likely that recession will be declared for 2008, particularly following the collapse in small business optimism reported for March.

Assuming that will be the case, a review of the four recessions since 1980 indicates that the USD did fall during the recessionary period, as might be expected. The transmission mechanism likely operates through monetary policy, with monetary easing (and lower interest rates) undermining the USD’s value. While there are a myriad of factors that have driven USD performance over recent decades, the tendency to fall in the recession period holds in each cycle and the combination of US recession and a record low for the USD in 2008 would be very consistent with that pattern.

Does history tell us anything about a potential USD rebound? In each of the four recession periods the USD bottomed at, or slightly before, the trough in the business cycle. In the convoluted 1980 recession, a short downturn that was at least partly precipitated by President Carter telling individuals to stop using their credit cards – only to quickly reverse himself – the bottom of the USD coincided with the trough of recession (July 1980). But in other cycles, the USD bottomed slightly before the trough in the business cycle, although only in the protracted 1981-82 recession was there an extended lead time (12 months).

Given this history it remains early for a clear USD trough to have been established. While there are signs that the worst in financial market stress may have passed, the downturn in economic momentum has gathered steam in recent months, with both the Chicago Fed National Activity Index and Small Business Optimism Index signaling recession. As a result, additional Fed easing during the months ahead is likely to weigh on the USD, and with the passage of the G7 meeting this weekend a EUR/USD test above 1.60 and a fall in the USD index to a new record low remain likely.