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Monday October 27, 2008 - 13:48:36 GMT
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And the Beat[Down] Goes On ...

Key News
• Australian Central Bank Intervened as Currency Extended Decline (Bloomberg)
• Dollar Rally Reasserts Greenback's Haven Status as Deutsche Bank Says Buy (Bloomberg)
Key Reports Due (WSJ):
10:00a.m. Sep New Home Sales: Previous: -11.5%.
10:30a.m. Oct Dallas Fed Mfg Production Index: Previous: -21.4.

“The increasing difficulty facing developing countries to roll over their foreign-currency loans may set the stage for even greater strengthening of the dollar.”

            David Woo

FX Trading – And the Beat[Down] Goes On ...

Ahhh, let’s see ... recent buzz words in the investor vernacular have been risky assets, subprime, inflation, decoupling, current account, globalization ... and the list goes on.

The newest buzz word to make the list: deleveraging.

I don’t have the hard stats, but I’d be willing to bet the instances of ‘deleveraging’ have increased exponentially if you were to search for the term on Google today versus two weeks ago. The simple reason is that it explains the ongoing US dollar rally.

Being dollar bullish, as we are, we’re even taken back a bit by the greenback’s persistent strength. I don’t want to try to imagine what a dollar perma-bear might be feeling in the midst of this historic move. The dollar has the upper-hand in a currency beat-down.

We’ve taken a stab twice now at what we expected to be a well-deserved and much-needed dollar correction. At neither point did any substantial corrective move occur. As has arisen in conversation with various reader and followers of ours, jumping in front of the US dollar right now is like jumping in front of a freight train – it simply doesn’t stop.

The deleveraging that’s taking place in emerging markets is fueling the drive. Also helping out is significant repatriation of funds to the US, a risk-averse environment. The downturn overseas and rush to the exit, evidenced in global stock markets, is simply creating demand for dollars.

One piece of evidence can easily be found in the Federal Reserve’s holdings of US Treasuries on behalf of foreign banks. Just this month the holdings have jumped by $60.1 billion, easily the largest one-month increase on record. Foreign investors are buying into bucks, or in other words, buying into safety.

After all, I think we’re seeing proof that the dollar is nowhere nearing forfeiting its position as global reserve currency. Credit and economic crisis isn’t sending money into Europe. Money is running into the euro for safety. Whoever thought the euro was ready to fulfill the role of world reserve currency can think again.

We’ve held the position that, despite our anticipation for a dollar correction, deleveraging and global economic deterioration will continue to drive the dollar upwards for many, many months ... at least.

So, the Big Questions are Still ...

Will we see a US dollar correction? If so, when will we see it?

To the first question, our answer is ‘Yes.’ To the second question, our answer is “We wish we knew.” But perhaps this week’s agenda will stir the pot a bit.

I mean, the Federal Reserve meets to decide on interest rates this week. Expectations are now calling for a considerable-sized rate cut – perhaps even down to 0.75%. While the economic impact of such a rate cut will be tough to measure, it likely won’t have nearly the desired effect of the members voting on it. Perhaps they should consult with the Bank of Japan on this strategy.

Anyway, with rates already the second lowest among developed nations, the US dollar isn’t really in position to be mortally wounded by a rate cut. In fact, the whole deleveraging dynamic playing out is accompanied by a reversal in carry trades. Both the dollar and the yen, which sports the two lowest yields among major currencies, are the biggest beneficiaries of global capital flows right now.

And to the point that the US dollar et al are in much need of some reprieve, the Reserve Bank of Australia just stepped in to intervene. The Australian dollar has fallen 23% versus the US dollar in the last month and 20% versus the Japanese yen in the last week. So the RBA bought up Australian dollars to help slow its decline.

At the rate many major currencies have fallen, it’s natural to expect they recover some ground over the near term. But, keep in mind ... it’s natural that the markets defy conventional wisdom too.

 (Chart unavailable in text format.)

Dollar perma-bears could very well be adding to the upward pressure. Something we’ve discussed and kept as a viable theme is a major capitulation among dollar bears. The snowball of dollar-bear converts seems to have already started rolling. And the fact that there are still plenty of bears out there citing US current deficit, inflation and whatnot means the prospect of major capitulation remains very much in play.


John Ross Crooks, III
Black Swan Capital LLC


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