Wednesday February 2, 2005 - 11:40:32 GMT
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Black Swan Capital - www.blackswantrading.com
The dollar, spu, and emerging market debt
“The longer animals can go without encountering the rare event, the more vulnerable they will be to it.”
Nassim Taleb, Fooled by Randomness
The chart below says if the stock market rallies, sell dollars—if not buy the buck. It compares S&P 500 futures to the US $ Index inverted so you can better see the correlation.
US $ Index inverted vs. S&P 500 Chart
If stocks rally it may be because Mr. Greenspan and Co. have signaled they will slowdown the pace in which they extract the punch from the party bowl. That would put us firmly back in the reflation mode. But based on everything we have seen and heard from the Fed, it appears Mr. G & Co. are serious about this interest rate “normalization” game.
Many believe the Fed has no choice at this stage (I fall into that camp)—too much liquidity has blown up too many bubbles. One example might be emerging market debt. The yield spread between emerging market debt and US Treasuries appears dangerously narrow to the casual observer. One little accident and that game could head into reverse very quickly (which would be beneficial to the dollar, I think, as the money rolls back onshore).
I think it would be safe to say gold is more sensitive to global macro monetary conditions than stocks. (Stocks tend to trade more on real stuff such as earnings and cash flow; whereas gold embodies much in the way of sentiment.) If that’s the case, the next chart might be a bit disconcerting to stock investors. It compares the S&P futures to gold futures weekly…
Gold vs. S&P 500 chart
It appears gold is leading the way. It makes sense given the potentiality of the Fed’s campaign. As the Fed raises rates, it drains off liquidity—the mother’s milk of the stock market. Many believe we need not worry because the Fed can ill afford to raise “too much” lest he push the indebted US consumer over the cliff. And I’m sure, or I hope, that’s been debated long and hard by the FOMC.
But, I think the Fed’s prior actions—pushing the Fed Funds rate to incredibly low levels—have sealed its fate. When a dealer quotes a yield to maturity on Lithuanian bonds, and you’re not sure if he means US Treasuries, you know there is something fishy going on out there. Mr. Greenspan is a very smart man; that I know despite my juvenile jabs at him on occasion. I don’t think he wants to be remembered as the central banker of bursting bubbles. It’s bubble deflation time.
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