Monday January 14, 2008 - 12:51:28 GMT
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Black Swan Capital - www.blackswantrading.com
A New Dollar Low in the Cards?
FX Trading â New dollar low in the cards?
The US dollar is getting smoked this morning. It seems the crowd did a weekend dollar re-think on the grounds of yield differential.
We showed the potential for a ratcheting down Fed Funds rate in our Currency Currents on January 4th via the Fed Funds rate chart comparing the relatively tentative Fed cuts so far to the aggressive campaign ushered in by Mr. Gâs Fed back in 2000. Back then we saw 13 cuts and six were of the 50 basis point variety. One could make the case that credit and housing woes today are much more serious than the deflationary threat faced by the economy in 2000.
We think it is finally starting to hit home just how deep the Fed will have to ratchet down interest rates in an âattemptâ to save the US economy. We use the word âattemptâ for a reason. At different stages of the cycle, the economy reacts much differently to monetary stimulus. And we could be at that precarious stage where Fed pumping will not be met with economic response, thus leading to more pumping. This is why interest rates can go a lot lower than still now expected.
From Hoisington Management 4Q 2007 Outlook [our emphasis]:
âA great deal of monetary analysis rightly focuses on the role of the Federal Reserve in creating money (exogenous money), and the power it has in fostering economic growth. Indeed, with a âstroke of the penâ the Fed adds reserves to the banking system. This raw material is multiplied into investments and loans, creating additional deposits and eventually economic expansion. However, three important constraints operate on the seemingly all-powerful Fed. First, no one in the private sector may wish to borrow. Second, impaired balance sheets may preclude the financial intermediaries from taking risk and extending credit. These first two conditions result in a buildup of reserves on bank balance sheets, with no loans or deposits being created. Of course a modern example of this central bank impotence is Japan, where no amount of reserve creation has fostered strong money growth or meaningful nominal economic activity for nearly two decades.
The third tether on Fed manipulations is the role of the private sector in creating money, known as âendogenous moneyâ, or in Irving Fisher terms, velocity (V). The monetary process captured by Irving Fisherâs equation of exchange (GDP=MxV) states that nominal GDP is equal to the stock of money (exogenous money supplied by the Fed) multiplied by the velocity of money (endogenous money created by the private sector). Under the right conditions, private sector activities can mitigate, and possibly overwhelm, actions taken by the Federal Reserve. Historically, swings in velocity have neutralized changes in the money stock many times, and currently appear to be having a profound affect on nominal GDP. During the past six quarters velocity has declined from 1.930 to an estimated 1.902 in the final quarter of 2007. At the same time, the annualized six quarter growth rate of M2 has accelerated to 5.9% from 4.3%. The interaction of these two forces has slowed the nominal growth rate to 4.9%, or 1.7% lower than the six quarter annualized growth rate prior to the peak in velocity a year and a half ago
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