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Tuesday June 2, 2009 - 17:14:40 GMT
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driving the Dollar seem to vary with the
season. Last fall at the height of the financial crisis safe haven flows trumped
all considerations; at one point investors accepted zero return for the security
of holding US debt. The Dollar rose 17%
against the Euro in a month and made
similar gains versus the Pound Sterling, the Canadian Dollar, the Swiss
Franc and the Australian and New Zealand
Dollars. But even at maximum market panic Dollar superiority was not total; the
imploding Yen carry trade drove the Dollar down against the Yen to 90 to the Dollar despite the huge inward flows to US
The Dollarâ€™s virtues
last fall were very specific; in a catastrophe everyoneâ€™s first choice for
safety was American debt. The Dollarâ€™s
competitive value was not the point, only its supposed security mattered. But
those conditions could not last, and as the financial crisis became an economic
crisis and the threat of financial system collapse waned the fear of wholesale
loss of investment principal ebbed. In moderating circumstances the funds that
had been stashed in the States for safety
(and little or no return) began to be withdrawn seeking other more productive
currencies and investments.
degree of panic into the Dollar last fall
guaranteed a correction out of the Dollar; but until the recent move that began on
May 20th, the Euro had stayed below the
38% Fibonacci retracement level of the July to October 2008 collapse.
dollar equilibrium held from mid March until mid May with the pair largely
confined to the range of 1.3100 and 1.3600. The original burst through that
range on March 18th and 19th was prompted by the Federal Reserve announcement
that it would buy Treasury Notes in an effort to keep consumer and mortgage
interest rates low; this was the so called â€˜quantitative easingâ€™ policy. The
Federal Reserve Board knew that the amount of US debt scheduled for sale to the
credit markets in the months ahead could undermine its low rate policy.
Mortgage rates are not set by Fed fiat but take direction from the
credit markets and one of the important
market benchmarks are US Treasury rates. The initial market reaction to the Fed
quantitative policy was extremely negative for the Dollar with the Euro gaining seven hundred points in two days.
But despite the Fed announcement traders
seemed to forget, the market absorbed that news and the Dollar regained all that it had lost after March
Enter the budget of the new American administration and its blueprint for the US economy. Treasury rates at
the long end of the yield curve have been rising since March. The ten year note
has gained 1.5% in yield in that time. The bond market clearly anticipated the
impact of the governmentâ€™s financing plans well before the actual auctions
began. But the turmoil in the bond market
did not dramatically affect the currency markets until last week.
classic economic comparison higher interest rates are one of the prime drivers
of a currencyâ€™s worth. US rates are clearly headed higher, though not at the Federal Reserve level, but
the Dollar has moved from strength to
weakness. Gone is the Dollar support from the
expectation that the US economy, under the spur of historically low rates
and massive fiscal stimulus, will be the first industrial economy to leave the
recession. Gone is the credit to the Fedâ€™s early acknowledgement of the
financial crisis and actions to mitigate the recession.
The correction out of Dollar assets will run its
course. But the currency market focus
on the amount of Fed quantitative
easing, on the US deficit and future inflation, will
remain. There is little confidence that a government as indebted as
Washington will be able to withdraw the liquidity flooding the US financial
system. The may even be the suspicion that Washington will realize that
monetizing the debt is probably the only politically realistic course to
alleviate the debt burden
The same proactive Fed and government policies
that only a few months ago were seen as strongly supportive of the US economy
and the US Dollar are now the Dollar's nemesis. Is the Treasury is the new driving force behind
the Dollarâ€™s fall?
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