Tuesday April 12, 2005 - 10:43:02 GMT
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Black Swan Capital - www.blackswantrading.com
Dollar camp may depend on bonds
“Now that the contrarian viewpoint has become the prevailing bias, I have become a confirmed anti-contrarian.”
George Soros, Alchemy of Finance
Currencies are very quiet this morning in anticipation of the US trade deficit report for February. But my question is: What the heck is up with those bonds?
Bonds seem so innocuous you tend to forget they are still wild. After all, they are recommended as companions for orphans and widows; and others who shun hostile environments like to hold them. But just when it appears safe to start giving them away, they rise up on their hind legs and take a chunk out of you.
The Fed says focus on “inflation,” forget about the job market, income growth, and booming monetary base. And the market says “buy bonds,” because jobs seem scarce, income growth is low, and liquidity is booming. Something doesn’t wash!
In the charts below, you can see that since the Fed began hiking rates in June 2004—seven ¼ point hikes taking the funds rate from 1.00% to 2.75%--the money supply, measured by M2, has continued to ratchet higher and 10-year bond yields have fallen.
charts: fed funds. 10-yr yeilds, M2
So, because the much heralded “inflation genie” is yet to emerge, and given the continued growth in market liquidity, it’s no surprise why the market keeps questioning whether Mr. Greenspan & Co. want to drain liquidity from the system or simply siphon a modicum of foam off the top of a very full punchbowl.
There seems little doubt this ebb and flow of “The Fed is aggressive!” vs. “The Fed is faking it!” will continue to add doubt about the direction of the dollar.
I believe the Fed is behind the curve. That positions me in the “The Fed is aggressive!” camp. And by extension, supports a view of intermediate-term dollar strength (despite a belief in a short-term dollar correction). But if the bond beast rises up again and shows its teeth…who knows!
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