Monday July 25, 2005 - 10:35:41 GMT
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Black Swan Capital - www.blackswantrading.com
“No matter how rational the original decision was to enter into a trading position, the very act of dealing moves an individual into a less rational, crowd-type environment.”
The decision by China to revalue its currency 2.1% against the dollar last Thursday is still the driving theme in the market. Two polar extremes are competing in the market of expectations:
View #1: The Chinese move is nothing more than cosmetic and their currency will trade within a very tight band around a newly pegged parity to the dollar.
Implication: No change to the script the dollar moves higher on an intermediate-term basis on growth and rising dollar yield differential.
View #2: This move will lead to a quick and continuous appreciation in the Chinese currency, dragging the entire Asian regional currencies higher with it.
Implication: The dollar falls against the yen and Aussie—and maybe the rest of the pack on the expectation that Asian central banks will no longer need to hold US Treasury paper in the quantities they now do. But again, allocation or reallocation of existing Chinese reserves comes back to the specific currencies and their allotted weights within the so-called basket.
(But this scenario of US Treasury bond selling leads to sharply higher US interest rates as a result. That in turn would hamper US consumer demand—still the key customer for Asian goods. Unless the Asian players believe their domestic consumer markets can take up the slack, they might hesitate to dump US paper as many now expect.)
The fact is no one is quite sure as of yet what the implications will be, if any. China has not defined the basket of currencies they will use for future valuation. Nor is it clear how much or how often China they will allow the yuan to appreciate even with a basket index. We suspect that’s why the dollar rallied sharply on Friday, reversing the knee-jerk sell off on Thursday, as market participants do a re-think or reality check.
For now we will continue to monitor the expectations against reality as China makes its position more clear in the coming days—assuming they choose to do so.
Black Swan Capital
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