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Monday May 15, 2006 - 14:39:09 GMT
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Weaker Dollar Gets Blame For Everything Including Stronger Dollar

Not since global warming has been blamed for everything from the demise of polar bears and penguins to hurricane Katrina, has so many things been blamed on the dollar...lower stocks, lower commodities, lower emerging bond markets, lower emerging currencies, lower US Treasuries and a higher dollar.

That is right...a falling dollar, with the Bush administration's quiet blessing, is causing the dollar to strengthen today. Before we cry foul, there is a kernel of truth to this otherwise preposterous assertion. Risk premia that were so drained from capital markets in recent years as credit cheapened, have done an about face and are showing up everywhere...as they should. Risk aversion is up and up at a point in time when arguably speculators are more levered up than at any time in recent memory...long gold, base metals, oil, carry trades, agency debt, corporate debt, equities and emerging markets (currencies), and short dollars.

As two-way risk seeps back into the markets it follows that some dollar short covering should unfold. But this by no means is the end of the dollar downtrend. I would argue the trend is in its early phase. With the WSJ Saturday reporting, and what I have argued for months, that a lower dollar has the quiet blessing of the Bush administration, as long as the move remains orderly, one should expect plenty more new lows ahead for the dollar. Indeed the dollar bounce today is healthy. It clears the deck of weak shorts and will draw in new sellers. Moreover, the bounce increases the odds of an orderly move down and less need for any coordinated response from G7 despite Japan's current rogue attempts to talk the yen down.

Surely some more lasting damage is being done to the emerging market longs, equity longs, commodity longs. Pricing in perfection from Brazil to Turkey is well delusional.

And I would observe that the dollar crisis is not gathering on the horizon at this stage. G7 ex-Japan is eager to see an orderly adjustment process begin and is ready to coordinate a response if it were to become disorderly (a low probability outcome, but an unacceptably high cost). The current account crisis trade would see the dollar, bonds and stocks all collapse in price (yields spike).

I suspect that the Fed pause, ECB tightening and eventual tightening by the BoJ will keep the cyclical theme dollar negative. And G7 has helped refocus market attention on global imbalances and the need for sharing the adjustment burden - I am betting on an orderly decline in the dollar and back up in Treasury yields ahead, post shifts in risk aversion.

David Gilmore
FXA
www.fxa.com


 

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