The volatility, the geopolitics, the worries over slowing economic growth weren’t bad enough—now we have to keep an eye, like we’ve got one to spare, on currencies.

I’d argue that over the last two weeks to a month, the rising dollar has been the most under-appreciated driver of stock prices. And the weeks ahead are setting up the dollar, the euro, the Chinese renminbi, and the Brazilian real as big market movers. The reversals and the rallies of the next month are likely to signaled by, related to, and amplified by currency moves.

Watch carefully if you want to catch the next rally—and avoid getting blindsided by the next reversal.

Look at the dollar’s climb against global currencies from August 30 to September 27. During those four weeks the dollar gained 7.7% against the euro, 8.8% against the Australian dollar, 9.0% against the Norwegian kroner, and a whopping 15.4% against the Brazilian real. Even the Chinese renminbi lost ground to the dollar, as Beijing let the current slide to a 3.6% decline versus the dollar.

The Why? is pretty simple. Read more

Business as usual: Euro falls, dollar climbs, stocks tumble

Today the euro is down and the dollar up. That means commodities stocks are down.

Yep, the relationship between the euro and the dollar remains the big driver in global financial markets.

Today, May 20, the euro fell against the dollar for the first time in five days. That has put an end to the rally in U.S. stocks that took the Standard & Poor’s 500 from 1328.98 on May 17 to 1343.6 yesterday, May 19. Today the S&P 500 finished down 0.8%.

Today’s big, bad news for the euro comes out of the European Central Bank, the week’s currency Grinch. After throwing a tantrum yesterday over talk of restructuring Greek debt—No, Nein, Non!—another member of the bank’s governing council weighed in with remarks that the bank could stop accepting Greek government debt as collateral for loans to Greek banks in the case of a reprofiling of Greek debt. (In a reprofiling Greece would keep paying interest on its debt but bondholders would agree to stretch out the maturity of that debt. That way Greece would be under less pressure to refinance maturing debt at the punished rates—about 25% for Greek two-year notes–in the financial markets.)

If the European Central Bank stopped accepting Greek government bonds as collateral for loans to Greek banks, those banks would stop buying Greek government debt. And that would produce exactly the kind of financial crisis that the bank says it wants to avoid.

Why the seeming contradiction? Read more

Sinking euro and rising dollar turn commodities retreat into a rout

Just what commodities and commodity stocks didn’t need today: A drop in the euro has produced a stronger dollar, which is, in turn, pressing commodity prices lower. Much lower. Gold fell by $50 an ounce today. Oil broke below $100 a barrel for the first time since March. Silver fell by another 10%.

The drop in the euro is a result of the European Central Bank’s decision not to raise interest rates at today’s meeting but instead to instead wait until at least June.

A delay until June shouldn’t have come as a surprise to anyone since I think bank President Jean-Claude Trichet signaled that June was the likely next stop on the interest rate train when the European Central Bank raised its benchmark interest rate to 1.25% on April 7.

That was the first interest rate increase from the European Central Bank since 2008. And the markets saw it as the first of a series of increases to fight inflation that hit 2.8% in April, well above the bank’s target of close to but below 2%.

On that conviction, markets bid up the euro against the U.S. dollar. The Federal Reserve seems unlikely to raise U.S. interest rates until late in 2011 at the earliest and that meant euro interest rates would be climbing while U.S. rates were sitting still for six months or more. And that increased the attractiveness of the euro against the dollar.

Today’s lack of action by the European Central Bank disappointed not only those who had read the bank’s April move as a promise of another increase in May, but also worried those who are counting on the bank to move strongly against inflation even if with a delay. In today’s statement Trichet didn’t use the phrase “strong vigilance” that has come to be the bank’s signal of an impending rate increase. Instead he said only that the bank will monitor inflation risks “very closely.” Some investors have concluded from that the bank doesn’t intend to raise rates in June either but will instead wait for July.

That worries the financial markets since it might indicate that the bank is so concerned about the debt crisis in Greece, Ireland, and Portugal that it is willing to tolerate more inflation in order not to further stress those economies. With no end to the economic difficulties in sight that possibility suggests that the European Central Bank might be less than its usual inflation-fighting self for the foreseeable future.

I don’t know how the central bank disproves that worry except by raising interest rates in June or July. Until then, the euro is going to have quite a few days like today. Which, of course, would be good for the dollar and not so good for commodities.

Why should Standard & Poor’s have all the fun?

On April 19 S&P shook global financial markets by putting U.S. government debt on negative credit watch. If the United States doesn’t get its budget act together, S&P warned, it would take away the country’s AAA credit rating.

But why stop there? What about Japan? Does a country with a gross public debt of 229% of GDP deserve an AA- rating? The United Kingdom at AAA? Brazil? Colombia? Germany? How do they stack up?

It’s time to become your own credit rating company and to fill in the gaps left by yesterday’s headlines.

Yep, you should make up your own list of good credits and bad credits so that you can figure out how to allocate your portfolio. Downgrades and upgrades are going to come faster than an avalanche moves downhill. And you’d like to be on the right side of those moves.

Seem too hard? Well, it would be a daunting task if your ratings had to include the detail that S&P, or Moody’s or Fitch Ratings do. But for your portfolio purposes, you don’t really care about the differences between AA+ (Belgium according to S&P) and AA (Spain). Actually you don’t are much about this kind of static rating at all. What you want to know if what direction a county’s debt rating is head in—and for that what I call Jim’s Bucket List is a more than good enough place to start.

It’s certainly enough so that you figure out what currencies you’d like to be holding in your stock portfolio 10 years from now. (Think the U.S. dollar is going to hold its value over that period?)

My system requires just four big buckets. Let’s start with the top bucket. Read more

Financial markets punish dollar and not Treasuries–so far

So why is it that U.S. bond prices aren’t sinking and why is it that U.S. bond yields aren’t sinking?

Can’t be that overseas investors found last week’s near shutdown of the U.S. government a reassuring sign of Washington’s fiscal responsibility.

Yields on U.S. bonds are lower now than when the government was running a budget surplus a decade ago—and when the amount of U.S. government debt outstanding was much, much lower. Marketable debt outstanding has climbed to $9.13 trillion from $4.34 trillion in the middle of 2007.

But the yield on the benchmark 10-year Treasury is just 3.49% as I post this on April 12. The average yield from 1998 through 2001, according to Bloomberg, was 5.48%.

And overseas investors aren’t fleeing the U.S. Treasury market. Foreign central banks bought 60% of the $66 billion in 10-year notes sold this year, up from 42% in 2010, according to the U.S. Treasury. Foreign investors as a whole owned $4.45 trillion in Treasuries as of January 2011, up from $3.7 trillion in January 2010.

The market certainly doesn’t seem to be worried about the chances of a U.S. default. Credit-default swaps on U.S. Treasuries—a kind of insurance against a bond issuer defaulting—stand at 0.415 percentage points. That’s a drop from the 2011 high of 0.515 on January 27.

I can think of two explanations for this—and, no, neither of them depends on overseas investors thinking U.S. politicians are any better at economics than they actually are. Read more