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Monday August 10, 2009 - 17:53:40 GMT
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The End of tghe Dollar Asset Bubble

The reaction of traders to Friday’s Non Farm Payrolls may be the most concrete sign that the currency markets are coming to the end of the financial crisis. The initial response was, as it has been since the unwinding of the security dollar bubble began in March, to sell the dollar against the euro.  But the dollar sellers exhausted themselves after barely five minutes and the following dollar surge, though also five minutes, covered twice a much ground. From 8:30 am to 8:35 am euro rose 34 points, from 8:35 am to 8:40 am it dropped 76; good American economic news had finally garnered a positive response from the currency markets.


From last September until March the dominant currency trade was a direct kin to the panic in the financial markets.  When in doubt, which was a constant, purchase dollar denominated assets. A huge bubble of Treasury assets were bought with foreign and domestic money. As the crisis rolled on, even though it had started in the US, involved many of the most prominent United States financial institutions, and called forth an unprecedented amount of government intervention and a deluge of dollar liquidity, nothing dented the dollar’s ascendancy.  Compared with the potential for the rest of the world the United States was the safest holder of wealth.

The strength of the dollar in this period owed nothing to the traditional standards of economic and currency comparison.  Though the amassing of the world’s financial liquidity in United States Treasuries would not typically be thought of as an asset bubble, by any measure of the origin and behavior of asset bubbles it was. Treasury prices were driven higher by unceasing demand which for a time ignored cost and return in a desperate race to secure principal.  The psychology of fear is not very different from that of greed in its ability to push markets to excess.  Bubbles can form for negative as well as positive reasons.

The dollar asset bubble began to unwind with the bottom of the equity markets in March.  If the September to March dollar was the security dollar then we can call the March to June dollar the repatriating dollar.

As financial conditions gradually improved, investors sold Treasuries and placed their funds in commodities, worldwide equities, currencies and other instruments looking for appreciation and return.  Because the process did not unfold at once, and because it was largely better conditions in the United States that emboldened investors to assume more risk, it seemed that whenever there were improving economic statistics in the US the dollar would sell off.  In fact this was the necessary dollar selling that accompanied the repatriation of foreign-owned dollar assets or American dollar assets transferring to overseas markets and investments. .

Neither the rationale for the security dollar nor the logic for the repatriating dollar could last beyond the original financial and market conditions that produced them. Owners of investment funds will not accept minuscule earnings forever. And despite appearances the amount of funds stashed in Treasuries is not infinite. When the repatriation is complete the pressure on the dollar engendered but not caused by a mending US economy will be removed.  We may have finally reached that point.

This does not necessarily mean that the dollar is poised for a strong recovery.  The US economy has very serious current and pending problems and the path away from the financial crisis to recovery is unknown; but then again that applies to the rest of the world as well. 

The Eurozone and Japan are trailing even the small signs of stability that have arrived in the United States. Still, if the historical performance of the US economy is considered along with the enormous fiscal and monetary stimulus that has been applied to the American economy, the dollar could well outstrip its competitors without the revival of normal economic growth anywhere in the world.

Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst

Joe@fxsol.com

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