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Monday March 8, 2010 - 14:28:51 GMT
Black Swan Capital - www.blackswantrading.com

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Maybe the Buck Loses the Next Race to the Bottom

Key News
European governments, led by France and Germany, are set to establish a European Monetary Fund, or EMF, with the aim of reducing economic instability across the eurozone by creating an institution to bail out indebted countries. (UK Times)
 
 Quotable 
“Once upon a time, nations took pride in their strong currencies, seeing them as symbols of economic and political power. Nowadays it seems as if the foreign-exchange markets are home to a bunch of Charles Atlas’s 97-pound weaklings, all of them eager to have sand kicked in their faces.”
  The Economist
 
FX Trading – Maybe the Buck Loses the Next Race to the Bottom
 
Now that global recovery is gaining momentum, according to the pundits, and risk appetite is back on the table, maybe the US dollar index is due for correction: [Chart not available in text format.]

Today, the dollar is testing the uptrend line going back to early December ’09; that’s when this rally began. 
 
No doubt near-term the risk appetite train, and all its tight correlations strapped to it, may hit the buck. But the game may have changed on the correlation front. Already we have seen a bit of breakdown between the dollar and the stock market. Interestingly, given the big run up in stocks on Friday, gold prices were flat. Maybe Mr. Market is telling us he isn’t going to make it so “easy” for us to discern tight correlations going forward.
 
From a currency perspective, we think now many competitors are in the race to the bottom. We think these competitors are in a position now to race faster than the buck and then take the crown the US dollar has so consistently defended since the bear market began in 2002. 
 
Overriding reason why the competition wants to run weaker than the dollar: despite the trend of improving manufacturing and order books globally, there is still a huge question about the sustainability of final demand for these goods.  
 
Europe: Final demand will likely be soft given austerity ... and will plunge if the “accident in the making” happens.
 
Japan: They continue to make it clear to the market their economy is in trouble and they will provide liquidity and lower rates as far as the eye can see.
 
UK: They look to be the sleeper in this race to the bottom. The case is built by the experts why it makes sense for the pound to jump out into the lead. The below excerpt is from a piece written by Anatole Kaletsky, “Rejoice—the pound is down again;” it appeared in the TimesOnline today:
 
A weakening pound is good for Britain at present, not only because it tends to boost economic growth by making British goods and services more competitive on world markets, but also because it will help to rebalance the structure of the economy. If Britain has become overly-dependent on consumption, housing and government spending, then a weaker currency is one of the most effective ways of redirecting resources towards exports and manufacturing. And manufacturing is not the only sector that benefits from a weaker currency. Financial and business services will also enjoy a boost from the weakness of the pound. The City of London mostly bills its customers in dollars and euros, but pays costs denominated in sterling. As the pound has fallen, therefore, Britain’s financial and business services have become much more profitable, helping to offset the increased taxes and regulatory costs and discouraging the exodus of business from London to Geneva or Singapore.
 
The first qualification to the general rule that a weak currency is good for the economy is that, while a weak currency helps businesses and boosts profits, it hurts the purchasing power of the British people who want to spend their money on foreign goods, holidays abroad or villas in Spain.
 
The second, more substantial, objection to a weak currency is what it can do to interest rates, if the Bank of England reacted to the falling pound by raising short-term interest rates or if investors responded by selling British government bonds and thus driving up long-term rates.
 
This is what often happened in “sterling crises” in the bad old days when Britain’s economic managers were obsessed with trying to fight off the speculators attacking various artificial currency regimes, most recently the European exchange-rate mechanism, which blew up in 1992.
 
Since 1992, however, neither the Bank of England nor the Treasury has made any effort to “defend” any particular value of sterling — and the chances of the British authorities suddenly deciding to do so in the future are virtually nil. And as long as the Bank keeps short-term rates near zero, long-term bond yields will also remain very low, as they have in Japan. This will remain true, almost regardless of how much money the Government needs to borrow, for the simple reason that banks will continue to be guaranteed an enormous profit if they can borrow for next to nothing from the Bank of England and then lend-on the proceeds to the British Government at interest rates of 3 or 4 per cent.
 
Anyone who believes, therefore, that a weakening pound will somehow force British interest rates to move sharply higher has not been paying attention to the changes in economic management, not only in Britain but around the world, since the early 1990s. In this new philosophy, a weak currency is something to be desired and encouraged during periods of recession, when employment and output need additional stimulus.
 
Europe wants a weaker euro. Japan wants a weaker yen. Switzerland wants a weaker franc. The UK wants a weaker pound. China wants to export. Ditto the rest of the Asian block; a group that has tried hard to keep a lid on their currency values having to compete against the Chinese trade juggernaut. 
 
Commodity currencies look fairly valued. But the buck looks increasingly undervalued given the needs of the rest of the world. And this goes to the point we made a few weeks back -- it behooves the global economy for the dollar to rally; these are the potential benefits:
 
1. Increases purchasing power of the world’s largest pocket of consumers to take all the goods others wish to export
2. A stronger dollar could likely improve the sentiment regarding the Treasury market quality, the world’s premier “risk free” asset class
3. Pressure valve opens for Europe if the dollar rallies
4. China can maintain its peg and point to its acceptance of a strong domestic currency as a result; this may help blunt protectionist pressures
5. A rising dollar and stock market has the possibility to create a positive self-reinforcing flow of much needed capital for real infrastructure build within the US
 
So, no doubt it seems a dollar correction, or at least consolidation, may be due. But longer- term, unless the US government decides to get in the way (which we can’t underestimate those chances), it would seem a rising dollar may be just what is needed by the major players. 
 
Of course, all bets are off given a major accident occuring out there. 
 
We don’t think the dollar rally bet is off because any type of major risk event (European default or China contraction on credit troubles are just two that seem in the mind of the market) will likely rally the dollar on safe haven. But said accident would likely be incredibly damaging to the global economy growth momentum underway and enough to drive that double-dip recession many are still so worried about. That would change the dynamics for all the competing currency classes ... and a new race begins.
 
Jack Crooks
Black Swan Capital
www.blackswantrading.com
 
Currencies are another asset class …
 
David Newman here… “Investing vs. Trading”
 
How many times have you seen pictures of people sitting on the beach with their laptop in hand in those “Trade Forex, Commission-Free!” advertisements? “Open an FX account, quit your real job, sit on the beach and get rich” is the implicit message. It’s ridiculous! But unfortunately that is what sells. 
 
It doesn’t have to be that way. You don’t have to buy into the hype ... and you don’t have to take that much risk in order to get involved in currencies. Trading can be profitable; but it requires extreme focus and discipline. There is another way if you want to “invest” in currencies.
 
Investing in currencies for the long haul means using currencies as another asset class in your portfolio. An asset class that will stand along stocks and bonds and hopefully provide some much needed diversification. 
 
There are plenty of low leveraged long-term investment choices available to you so you can make real money in currencies. They are called Currency Exchange Traded Funds (ETFs). 
 
An ETF is a simple straightforward currency product that you can buy and sell in your standard equity brokerage account. It’s the same as buying any other fund traded on the exchange. We offer recommendations on Currency ETFs in our month Currency Investor newsletter. We don’t recommend trading them; we do recommend investing in them using a long-term buy and hold strategy. 
 
To sum it up: Our monthly Currency Investor newsletter is geared toward newcomers and experienced investors who are looking for a conservative approach to the foreign exchange market, and learning more about how the global economy works.
 
In plain language we deliver global macroeconomic analysis and actionable ideas geared toward exchange rate fluctuations over time.

Our analysis is comprehensible and our recommendations consist of ETFs, as I said. So don’t get turned off by buzz words like “exchange rates” or “foreign exchange” – this investing strategy is as easy to implement as buying and selling stocks.
 
Plus, at $39 per year it’s a deal you’d be hard-pressed to find anywhere else.
 
Thorough global analysis plus complete investment guidance ... and all for only $39 per year? You can become a Member of our Currency Investor service at our homepage via credit card or PayPal.
 
Thank you.
 
All the best,
 
David Newman
Director of Sales and Marketing
Black Swan Capital
dnewman@blackswantrading.com 
Phone: 866-846-2672
 

 

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