Tuesday January 11, 2005 - 11:39:13 GMT
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Black Swan Capital - www.blackswantrading.com
Dollar weakness: The current account--again?
“While reflexive interactions are intermittent in the stock market, they are continuous in the market for currencies.”
“As policy makers continue to publicize policies that ultimately favor a stronger dollar, a majority of analysts believe the dollar will begin falling again at some point based on concerns about funding the U.S. current-account deficit,” The Wall Street Journal reported this morning. Two days of dollar decline and its back, the same rationale that we have heard for at least a year or more (drum roll please)…the current account deficit.
Below is an excerpt from a Special Issue to be delivered to Black Swan clients today. Can’t the analysts pull-out a better reason to sell the dollar, something different than the current account? Isn’t IT getting a bit stale?
Granted, the soaring current account created the fertile ground to swing dollar sentiment decidedly negative. But is the current account the key reason for the dollar’s decline? Or is that, in our zest for rationality, we irrationally give greater weight to those variables we can identify, as opposed to those we cannot, which unfortunately represent the bulk.
The number of underlying fundamental variables impacting the dollar is both diverse and illusive. This is why currency trading appears so irrational. It is irrational much of the time, especially as we narrow the time frames. It’s why currencies are more vulnerable to investor sentiment than any other asset market. It’s why we see such large “over shooting” in the currency markets. But none of this nullifies the eventual impact of the real underlying drivers of currencies; it only makes them harder to identify.
So, the current account became the key indicator in the currency forecasting game. Most commentators have focused on the current account because it was an easy story to tell. However, in addition to the current account story, there were plenty of reasons why the dollar may have declined in 2004, and in preceding three-years. Here a few…
1) The yield on US dollar deposits declined relative to the other major currencies.
2) The bursting of the stock market bubble in 2000.
3) The Fed’s decision to run the printing presses 24/7 to fight deflation (supply & demand)
4) China supplanting the US as the world’s major destination for foreign direct investment
5) Foreign concern about US dominated assets following 9/11 and the “War on Terror”
… Even if we accept that the current account is a viable rationale, the fact that everyone knows about it tends to mute its impact. “The wider the use of an indicator, the less useful it becomes in beating the crowd, wrote F.J. Chu in his excellent book, The Mind of the Market.
Maybe it is as simple as implying that each time US Treasury Secretary Snow opens his mouth, he really means something else. He’s really saying: Sell the dollar when he says he wants a strong dollar. Maybe he knows nothing about interest rate differentials. Maybe he doesn’t realize that US fundamentals are in better shape than most of its competitors (despite the Double-D’s of Doom). Maybe he just got the job because of his pretty face. Until there is a better, fresher rationale to sell the dollar, I’m looking at the move over the past two days as nothing more than a dollar correction to a multi-month uptrend.
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