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Thursday October 28, 2004 - 22:51:11 GMT
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Forex: Sell Dollars Or Get Out Of The Way

Sell Dollars Or Get Out Of The Way

First of all this is not about me. What do I mean? I mean my being bearish on the dollar is a view...impersonal. It is the preponderance of evidence for selling dollars and not some attempt at aggrandizement that motivates my take on the dollar.

The price action today speaks volumes. Most importantly the rate hike by China today that sent A$ and C$ down sharply vs. US$ given the implications for commodity prices (of slowing Chinese demand), did not last long at all, even though the initial pain was severe. Moreover, the dollar generally reversed most of the gains on the rate hike (as did bonds with losses). Sure there was good reason to question the impact the rate hike would have given the infancy of the Chinese banking system and the government's well known intent to slow growth to around 7% from around 9% currently. China growing at 7% is not lights out for commodity prices, surely. Nevertheless, the fact that arguably positive dollar news is quickly chewed up and spit out by the market is the type of reaction one expects early in a move.

Secondly, the balance of remarks from senior monetary officials in the Euro Zone and US suggests the concern over the euro rise expressed by German Chancellor Schroeder and the EU's Almunia earlier this week are not widely shared. While unnamed, several Euro Zone monetary officials today played down the significance of the pace and level of the recent euro appreciation (versus the dollar). One official said the higher euro probably delays a rate hike as it implies tighter monetary conditions. And the conditions for joint intervention, preferred by ECB officials when considering intervention, were not in place. Furthermore, the rise in the euro was noted as a welcome check on higher oil prices. Meanwhile with the dollar also weakening versus the yen and hence the euro not the shouldering the bulk of the burden of trade adjustment as Japan is not actively preventing the yen from strengthening, surely the Euro Zone tolerance for a weaker dollar and stronger euro is is not losing competitiveness vis a vis Japan the way it was earlier this year when Trichet called the rise in the euro to near 1.29 brutal. And, even US Treasury Under Secretary Taylor called the recent dollar moves orderly. Rest assured no one in the Bush administration is losing sleep over the declining dollar...not with this employment record and not with the election just a few days away. Japan's economy too is arguably closer to a sustainable growth path than in a decade and more insulated from a yen-related downturn than it was earlier this year. The bottom line here is currency intervention is not imminent. Japan surely will be most inclined to act first. But even when it shows its hand in FX (say on a break of 105 in dlr/yen...the consensus view), the aim will be smoothing, not preventing, yen appreciation. And where is the ECB likely to intervene in euro/dollar? Probably well north of 1.35, and much will depend on the pace of appreciation, where oil is and the willingness of the US to participate (low for Kerry and Bush). Indeed it is difficult to see the US intervening in euro/dollar short of a disorderly move where asset prices are being impacted. From the official side verbal intervention is about all one should encounter selling dollars for the period ahead.

Thirdly, the headwind the US economy is facing is fierce even if oil settles at $48 as opposed to $55. Corporate profits are at risk as oil will shrink margins and firms lack pricing power. Household spending is also pressured by the oil tax as demand is inelastic and incomes are not rising nearly as ast to keep pace with higher fixed expenses. Yes this condition holds for all net oil importers. But if your currency is rising versus the dollar, the hit from higher oil is not as severe. Additionally the US current account imbalance is in the banana republic zone (as share of GDP nearly 6%) and any serious threat to the global economy may make funding this gap that much harder. And the US election next Tuesday could make the 2000 court-decided election look like a picnic compared with this year's election if the polls are accurate and the losing side unleashes teams of lawyers to challenge vote counts in swing states (some suits already filed). A court-challenged outcome next week would be a vote of no-confidence in the US political system and would have seismic consequences for US markets and the dollar and conceivably could force the Fed to hit the pause button November10.

Eliot Spitzer may not be a stand-alone reason for dumping dollars, but his work at exposing corporate malfeasance is a work in progress. Insurance this month, telecommunications next. Spitzer intends to leave no stone unturned. With Spitzer riding roughshod over corporate America, the notion of risk in being long US assets (namely equity and corporate debt) is at the very least worthy of questioning.

Finally, funds are tip toeing into this move down in the dollar which I believe provides a healthier basis for shorts...extending the downtrend. Real money has not gotten very involved either. If it does, the move could easily go another 10-15% by year-end.

So it is time to sell dollars or get out of the way. Some recently have asked if there is anything constructive too say about the dollar (why it may go higher). My answer was the best scenario for the dollar is that the US continues to attract enough foreign savings to keep the dollar stable. This will take turning a blind eye to the preponderance of evidence and being content with the notion hat all one needs for a stable to strong dollar is for the US to outgrow Japan and Europe. Well guess what? This is unsustainable and believing it is sustainable only makes the day it is not far more devastating.

David Gilmore


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