Tuesday April 26, 2005 - 11:17:27 GMT
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Black Swan Capital - www.blackswantrading.com
Fed weaning and the buck
“Some commentators have argued that the US has been reliant on foreign official inflows, and have been citing figures like ‘more than 50% of the US C/A deficit in 2004 was financed by interventions by foreign banks.’ …The key point here is that, at the end of the day, private flows are much more important than official flows. The notion that the USD was propped up by official flows is misleading and policy makers had better exercise care in conveying the right messages to the private investors, both US and foreign.”
Stephen Jen, Morgan Stanley
Morgan’s Stephen Roach penned a blistering attack on the Fed recently, his missive was titled, “Original Sin.” I think it is well worth the read regardless of your perspective.
Here is his summary [my emphasis]:
“The day is close at hand when US monetary policy must get real. At a minimum, that will require a normalization of real interest rates. Given the excesses that now exist, it may even require a federal funds rate that needs to move into the restrictive zone -- possibly as high as 5.5%. Yes, this would cause an outcry -- perhaps similar to that which occurred in the spring of 1997 on the occasion of the Original Sin. But in the end, there may be no other choice. Fedspeak has taken us into the greatest moral hazard dilemma of all -- how to wean an asset-dependent system from unsustainably low real interest rates without bringing the entire House of Cards down. The longer the Fed waits, the more perilous the exit strategy.”
It’s not clear if the Fed will heed Mr. Roach’s advice, but it seems the Fed Governors of late, Bies and Kohn, have been laying the groundwork for the weaning process. Governor Bies recently said in a speech that consumers and business would be able to deal with an increase in interest rates (as reviewed in Currency Currents last week). And Mr. Kohn told a gathering that yes there were imbalances, but the Fed would hike rates even if it jeopardizes the housing market (at least that is what I gleaned from his remarks .
If the Fed is starting the weaning process and yield differential is a driver for a currency (private capital flows as mention by Mr. Jen), and if positive relative economic growth, warts and all, is an underlying support (again private capital flow argument), maybe the dollar is in better shape from a flow standpoint than we now believe.
And given that European growth continues to disappoint. And given that “there is no reason for the European Central Bank to raise interest rates,” says German IFO Chief Economist Gernot Nerb, the euro just might be in more trouble than we now believe.
If we get a test of the recent lows in EURUSD (12733), we will probably have some clarity on all the “ifs”, “maybes”, and “mights” we should all have at this stage.
euro weekly chart
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