Friday March 11, 2005 - 11:36:14 GMT
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Black Swan Capital - www.blackswantrading.com
Dollar danger zone
“Wall Street’s graveyards are filled with men who were right too soon.”
Last Monday, Morgan Stanley economist Stephen Jen’s wrote, “The struggle between the structural USD negatives (the ‘twin deficits’ and all their derivative concerns) and the cyclical USD positives (a more hawkish Fed relative to the rest of the world and relative to current market expectations) will likely dictate the trajectory of the USD in the period ahead.” This week the structural negatives have taken charge. Asian bank exchange reserve reallocation (try saying that three times out loud real fast) has taken center stage as a reflection of US structural weakness, and seems key to the negative sentiment and primary catalyst for dollar selling this week.
Now the dollar is fast approaching its 2004 low. This should be considered a danger zone for policy makers of all stripes and sizes. I think that’s why dealers reported Asian monetary authorities intervened “heavily” to buy dollars. A breech of the 2004 low could lead to a self-feeding price-led spike down in the buck. That potentiality sets the stage for some ugly scenarios:
1) It would help validate the dominant sentiment that US structural problems are out of control.
2) That belief is fertile material for a wholesale run out of US assets, including the dollar, stocks and bonds. Such a scenario would be terrible news for the US consumer (or should I say the one remaining source of viable global demand) who is already laboring under piles of leverage used to finance home and auto ownership in addition to regular shopping mall excursions.
3) And with tension already growing in Washington over China’s huge trade surplus with the US, policymakers are likely to place the falling dollar, and evaporating US consumer wealth (if we see bonds and stocks follow the dollar lower) squarely at the feet of Chinese trade policy.
Keep in mind that as the dollar falls, the global price of Chinese goods falls, adding to China’s export competitiveness and global deflationary and wage pressure everywhere. (The decline in Chinese imports in February probably hasn’t past unnoticed in the halls of the US Congress either.)
We have an ugly historic precedent for global deflation and trade protectionism from Washington—it is called the Great Depression.
Now, don’t get me wrong—we are a long way from that, I hope. But events have a way of spinning out of control in financial markets quickly. It would seem to me that a falling dollar is more potentially dangerous to the global economy than it is helpful for the US trade deficit. And if others in a position to act on their beliefs feel the same way, there could be support for the dollar from some very deep pockets. We should be open to that possibility as the dollar tests its lows.
Today we get a look at the US trade deficit for January. The market seems to be expecting the worst. Don’t forget what happened last Friday, before the release of the US non-farm payroll report for February, the market was expecting the best and the dollar plunged.
It could be a very interesting day.
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