Friday March 18, 2005 - 11:08:52 GMT
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Black Swan Capital - www.blackswantrading.com
Dollar themes again
“Knowing the past, one reads the morning newspapers with a sense of fatalism. One believes in the powers of markets and reason but not in the perfectability of lenders and borrowers.”
Jim Grant, Money of the Mind
Over the past couple of weeks we have discussed a few background themes that we believed would help the dollar despite the continued rise in structural concerns:
1) Regarding the so-called reallocation of Asian central bank foreign exchange reserves: We said that Asia can ill afford to destroy its only viable customer—the US consumer. The recent announcement by the Bank of Korea and Japan that there will be no change to their dollar foreign exchange reserve allocation is strong validation that they know where they bread is buttered. So the music plays on.
2) Rising US interest rates pressure on emerging markets, and that in turn will support the dollar as money runs back to the US in safe haven fashion. Yesterday, stories abounded about the US Treasuries benefiting from money coming out of emerging market debt. The spread between emerging market debt and Treasuries was too tight for comfort anyway. If the Fed does the “right” thing, this flow out of the emerging markets should continue.
3) There may be a vested interest for those that have the wherewithal to keep the dollar from spiking down further. The concern being twofold: a lower dollar exacerbates the political pressure to do something about Chinese trade with the US and a falling dollar means the current account swells further while adding to global deflationary pressures emanating from China.
4) Commodities markets are overextended and despite otherwise glorious posted numbers, China’s growth may not live up to expectations in the near future. This theme is part and parcel to the pressure from higher US interest rates. Sooner or later, China will be forced to use the lever of higher domestic rates to cool its economy.
Though there will be on explicit indication where or not we are right about point number 3), it seems clear that point number 1), 2) and parts of number 4) are playing out to support the dollar. Or it could be, as we are fond of saying, just because we have price action going in the direction we expected, we are finding a story to fit. But we think the themes we have outlined make sense.
Yesterday, we saw a sea of red posted across many commodities, suggesting the reflation trade may either coming unwound or in rethink mode. This is yet another theme predicated on the predilection of Mr. Greenspan and his merry men at the Fed. If said reflation trade is coming unwound, one has to expect the Australian dollar feels the brunt of the pain. After all, it’s been a prime beneficiary on the way up.
Here is a chart we shared with clients yesterday. Though the correlation can’t be defined as direct, it makes the point that the game maybe over for the Aussie, but the Aussie players won’t let go of the ball. The divergence between the two price series suggest either the Aussie is overvalued or the Treasuries are undervalued, or a there is a bit of both. We don’t think 30-year Treasuries are undervalued given what we have seen from the Fed.
chart aussie vs treasuries
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