Thursday April 21, 2005 - 10:46:11 GMT
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Black Swan Capital - www.blackswantrading.com
Dollar following bonds...
“It took the crash of 1973-1974 to convince investors that these miracle-workers [Gerry Tsai of the Manhattan Fund and John Hartwell of the Hartwell & Campbell Growth Fund] were just high rollers in a bull market and that they too should be interested in risk as well as return. While the S&P 500 fell by 43% from December 1972 to September 1974, the Manhattan Fund lost 60% and the Hartwell & Campbell Fund fell by 55%.”
Peter L. Bernstein, Against the Gods
Dueling views again rule the day.
"The CPI data is not as bad as it first looked," said Dominic Konstam, head of fixed-income strategy at Credit Suisse First Boston in New York. "If growth is really slowing, inflation risk will dissipate very quickly,” Mr. Konstam told The Wall Street Journal.
“There is no inflation in the US if you don't drive a car or need to pay to deliver or receive goods, particularly if you don't eat or have holidays. And of course, everyone is naked, because what you spend on clothes isn't counted either,” according to Macquarie Bank FX Research.
I know it makes markets. Without dueling views, there would probably be no buying and selling. But the views are becoming polarized—someone is going to lose big and someone is going to win big—it seems.
Why the focus on bonds? The bonds and the dollar have traveled together lately—higher bond prices has equaled lower dollar. No surprise, as higher bond prices/lower bond yields represent the slowdown argument. Below is a chart of 30-year Treasury Bond futures (prices) compared with the US $ Index (inverted). The US$ Index inverted is the blue line:
Chart: bonds vs $ index (inverted)
So, all we have to do is predict long-term interest rates and we will know where the dollar goes. But that logic is a bit silly. If, for some reason, we could predict interest rates, we should buy a seat on the Chicago Board of Exchange and live happily ever after, not ever worrying about the dollar.
However, though we cannot predict the course of interest rates, I think we can continue to believe that if market data and anecdotal evidence is to be believed, inflation expectations should be rising despite the course of long bond prices.
Although I am no quant, by any stretch of the imagination, I have devised the following algorithm to suggest that bond prices may be higher than they should be:
Bond Prices ↓ = FF ↑ + IE ↑ + ~ BSE
FF = Fed Funds
IE = Inflation Expectations
BSE = Black Swan Event (that squiggly thing in front is to make it look more official)
For now, and though we are fighting the tape so to speak (not a good place to be), our story is the dollar goes higher over the intermediate-term once people realize the power of our algorithm.
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