By Chris Gaffney Currency traders dumped the dollar once again yesterday. The reason? A report came out yesterday that showed new home sales rose the most in eight years.

New home sales in the U.S. climbed 11% last month to a 384,000 annual pace. This was substantially higher than economists predicted, and the most since November. The report also showed the number of houses on the market dropped to the lowest level in more than a decade. The housing numbers seem to confirm that the housing market may be approaching a bottom.

But housing prices continue to fall, and more data is needed before I’m convinced the worst is over. Also, many of these homes have been sold to first time homebuyers taking advantage of government programs. If unemployment continues to climb, housing sales are not likely to rise quickly.

UBS: “Get Set for a Weak Dollar”

But the housing news was music to investors’ ears. Those who parked money in the dollar for ’safe haven’ purposes began looking for other places to invest. Many feel the worst of the global recession is over, as global data seems to be turning positive.

Adding to the good feeling on Wall Street, analysts raised their profit estimates for U.S. companies for the first time in two years. The new optimism has many investors searching for higher yields and accepting higher risks.

During the mid-morning trading, the dollar index touched the lowest level this year, dropping to 78.315 before gaining back some of its losses late in the day as U.S. stocks retreated from eight month highs.

A report from UBS, the world’s second largest currency trader, predicts the dollar will continue to drop during the next month amid a revival in risk appetite. “Our near term bias is for further U.S. dollar weakness,” a UBS analyst wrote.

Everyone seems to be jumping on the carry trade again, which should give a lot of strength to the higher yielding currencies of Aussie dollar, New Zealand dollar and Brazilian real. This will likely be the ‘popular’ trade for investors over the next few months.

Geithner: Bond Salesman Extraordinaire (We Hope)

The positive news for the global economy couldn’t come at a better time for U.S. Treasury Secretary Timothy Geithner considering he just began talks with China. Geithner and Secretary of State Hillary Clinton will host two days of meetings whichmeetings, which many predict will focus on the state of the U.S. economy.

Secretary Geithner will be wearing his bond salesman hat as he tries to convince the Chinese to keep buying Treasury bills, notes, and bonds.

This week the U.S. Treasury will attempt to unload $235 billion in Treasuries, so Geithner will certainly have his work cut out for him. The U.S. debt sales will include $130 billion of T-bills, $42 billion 2-year notes, $39 billion 5-year notes, $28 billion 7-year notes, and $6 billion of TIPS.

I find it odd that the U.S. government isn’t trying to sell more bonds out in the longer-term durations with rates being held down at these incredibly low levels. Does anyone expect U.S. interest rates to remain at these low levels for an extended period of time?

Why wouldn’t the Treasury department take advantage and try to sell more longer-term debt now, instead of selling most bonds on the short-end of the curve? I guess Geithner realizes selling all this debt will already be difficult. Getting foreigners to agree to purchase longer termlonger-term maturities would be next to impossible.

Let’s hope Geithner is a first class salesman, considering our economy depends on the Chinese continuing to buy our debt.

Unfortunately his boss isn’t making his job any easier, as the deficits continue to rise. The nonpartisan Congressional Budget Office (CBO) estimates the annual deficits under the administration’s spending plans will never drop below $633 billion over the next decade.

The CBO forecasts we’ll see another $9.1 trillion added to the debt held by the public. That’s the amount Geithner has to finance with bond sales.

Publicly traded U.S. debt – which excludes deficits the government owes to itself in Social Security and other trust funds – stood at 41% of the total economy in 2008. It is projected to climb to 82% of the entire economy by 2019.

The official line after the first day of meetings stuck to the pre-arranged script. Geithner pledged to rein in the U.S. deficit to a more ’sustainable’ level by 2013, and China agreed to try and stimulate more internal consumption.

China “Manufacturing” Their Own Customers

Speaking of Chinese consumption, I heard a story driving home on NPR last night whichnight, which talked about how China is spending their stimulus money. While the big infrastructure projects have grabbed most of the headlines, they have also used a large amount of their stimulus money to stimulate consumer buying.

For instance, the Chinese just issued vouchers to individuals living in lower income rural areas. These would-be buyers can trade the vouchers for consumer durables, including cars, appliances, and TVs. The increase in demand by the emerging Chinese middle class has actually caused a price jump for the panels used to make flat screen TVs.

Critics of the China growth story have said the Chinese economy couldn’t grow without a strong U.S. consumer. However, both my colleague Chuck Butler and I have pointed out that even a small increase in personal wealth spread across the millions of Chinese consumers could offset some of the loss from U.S. consumers.

What we predicted seems to be coming true, as the Chinese automobile market has become the largest in the world, and markets for other consumer products like flat screen TVs seem to be following suit.

This also plays into our theory that inflation will likely spike up after the global economy starts to recover. Inventories are extremely low, and once demand starts heating up in the western markets of Europe and the U.S., orders will again start flowing back into Asia.

But demand in Asia will be competing with these new orders from the West, so prices will likely jump.

Also, commodity prices have already started rebounding, including industrial metals and crude oil. This means inflation is definitely lurking, and investors need to protect their holdings against a possible spike.

To recap quickly: This week, we’re seeing the dollar falling on the good news coming out of the housing market (the jury is still out on that “good news” as far I’m concerned, but it is moving the markets this week). Meanwhile, Treasury Secretary Geithner is doing his best to market our debt all over the world, while the Chinese are pumping up their internal consumption.

All of this news is definitely causing dollar weakness this week. I recommend a combination of precious metals, or commodity based currencies to protect your holdings.

That’s it for today! Have a Terrific Tuesday,
Chris Gaffney CFA