The dollar made a dramatic 180-degree turnaround in value versus the euro over the past nine months. The euro was valued 1.35 against the dollar in January 2005. Today the euro is 1.21 versus the dollar, representing an approximate 11% loss in euro value. Currently, there is a differential between dollar value and euro value that ultimately favors the European export industry. Other central banks are currently aiding the Fed's effort to keep dollar value from further decline.
Perhaps the culprit behind the dollar's earlier flight was the tax break Congress offered corporations in late 2004. The new law allows U.S. corporations invested abroad a 5.25% tax on money brought back to the U.S. Over $200 billion returned to the U.S. nine months after the tax break was passed. It is highly likely that approximately $40 billion more will come back to the U.S. by the end of 2005.
The good news is the European economy is provided an approximate 11% bonus when investing in U.S. stocks and bonds. The bonus should be sufficient enough to attract European investors to U.S. markets so that, in the weeks ahead, there will be a stronger, more solid floor beneath the Dow 30 (i.e. 10200). The bad news, however, is the pressure a strengthening dollar will have on the price of gold.
As mentioned in the October issue of Kenneth Coleman's Investment Tracker newsletter, The Fed appeared concerned (at their last FOMC meeting) about the threat of rising prices. Former FOMC member Lyle Grammly registered his concern when he stated, "energy prices are now spilling over into core rates of inflation." Former FOMC member Janet Yellen wasn't "gellen" when she disagreed with Grammly on the issue. Yellen does not believe the inflationary threat is as serious as Grammly made it out to be.
Chief investment strategist Brain Wesberry of the Claymore Advisors is unconvinced the damage caused by last month's hurricanes will have any real long-term effect on the economy. Wesberry claimed the economy was very strong prior to the duo's rampage through the Gulf. He believes the hurricanes barely turned the economy down a notch. "We live in a massive economy. The hurricanes have hardly registered any real difference in it," says Wesberry. Wesberry also claims that it will take at least six more quarters before the U.S. economy faces another recession. He also felt that inflation is now in the 3.0% to 3.5% range and will peak at 5.0%. The unemployment rate supports Wesberry's position. Unemployment fell more than analysts estimated.
There is one factor involved in the inflation equation that remains to be addressed-the X-factored yield curve. Most conventional (non-money flow) analysts pay little or no attention to money flow. They only monitor the nominal yield curve, which only works well during periods of relative dollar value stability.
There was little or no need for an X-factored yield curve during the years when the U.S. was on the Gold Exchange System. Dollar value was maintained by the constant value of gold. Therefore, excess dollars were removed from circulation vis a vis buying with U.S. gold reserves if the dollar began to lose value. Nominal interest rates were able to measure the position of the economy in the business cycle at any given time due to a constant dollar value. Thus, the business cycle was a lot less complicated back then. Now that currency value dominates the economy to the extent that it can speed it up or slow it down (especially the import and export sectors), no one person can afford to neglect the effect currency value has on the yield curve.
The 3-year Treasury note turned negative when the current yield curve is X-factored. The Fed Funds Rate is still positive. Both short-term rates could go negative if the Fed raises interest rates again in November. The odds favor that the yield curve will turn negative if the Fed decides to raise rates two more times. They will negatively affect both gold and gold stocks and pressure oil, gas and real estate prices. This could prove positive for U.S. stock prices if corporations and the economy profit from these lower prices.
