Wednesday November 24, 2004 - 18:17:22 GMT
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Forex: FX Market Be Thankful The Dollar Is A Turkey
FX Market Be Thankful The Dollar Is A Turkey
Thanksgiving is a US holiday for sure (Canada has one in October). But this year it is a day that a larger global audience should be celebrating. The currency market should be thankful. Thankful that the market has come back from a rather dreadful year for the buy side after a promising Q1. In nearly eight weeks the dollar index has fallen nearly 6% to a nine-year low. Euro/dollar is up over 7%. Dollar/yen is down almost 8%. Dollar/Canada is down over 6% (down nearly 16% from the May high). The fall harvest in FX has been nothing short of miraculous and it should buoy buyside returns for the year. Moreover, there is a strong sense that the move lower in the dollar will persist well into 2005. Currencies are once again sexy. Even the diabolical Matt Drudge finds the headlines too enticing to ignore: "Euro Hits Another New Record Low". Business Week called me earlier this week for a dollar story...magazine headline can't be far off. Top sirens are sounding, no? No as in no. This time the pedestrian view will prevail for the foreseeable future. An orderly dollar decline with intermittent short cover bounces should be with us through at least the first half of 2005. FX should be the asset class that yields the highest returns for macro hedge funds for the next few quarters. Stocks more or less have had their run and the Fed is likely to wring out spread trades as it continues to lift short term rates and low inflation and Asian currency manipulation combines to keep long-term rates in check.
So whom should we thank on Thursday? Alan Greenspan for starters. We can thank him for telling investors and speculators it is okay to be worried about the record US current account deficit. And it is appropriate to expect pressure on the currency in absence of other adjustment measures liken US budget deficit reduction. So the weak dollar structural story went from the land of cranks to mainstream thinking.
We should also give thanks to John Snow. In spite of his name, the Treasury Secretary is doing nothing to prevent the dollar from melting. And in spite of strong dollar rhetoric, Snow and the Bush administration generally are quite happy to see an orderly dollar decline to fertilize external support for us growth. The US government has single engine fatigue...the US is tired of being the sole engine for growth in G7. Encouraging a market-based solution to the US trade gap is a potential windfall for investors and speculators short dollars.
And we should thank reserve managers...non-G7 central banks that are increasing euro exposure and decreasing dollar exposure in fairly massive currency portfolios. China has about $500bln in foreign currency and gold, and the majority of these holdings are dollars (close to 80%). Taiwan has about $240bln. South Korea about $185bln. Hong Kong about $120bln. Singapore about $105bln. India about $120bln. Russia about $113bln. This crew of central banks have been significant euro buyers and dollar sellers as they manage their collectively huge exposure to dollar-denominated assets. This crowd is doing exactly what Greenspan said is rational. They too have determined that the US current account expansion is in unchartered water and at risk of capsizing. The lifejacket here is diversification. And it is the very presence of these central banks that has allowed the market to ignore otherwise bullish cyclical or economic fundamentals for the dollar and focus on the impossible to measure (contemporaneously) structural adjustment.
Until G7 gets its act together (joint intervention), the decline in the dollar will continue. The pace of decline will accelerate and decelerate as in any healthy trend. There will be setbacks as well which any one-way market experiences...ask any oil trader. But the barn doors are open and for the time being it will pay to ignore the cyclical themes that support the dollar (the parachute for the descent) and ride the structural shifts that suggest a more seismic realignment in exchange rates.
Just maybe in 12 months time we will be thanking China too for revaluing the yuan.
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