Wednesday October 25, 2006 - 10:32:19 GMT
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Black Swan Capital - www.blackswantrading.com
The Deficit Fallacy
â€˘ German business confidence unexpectedly rose in October for the first time in four months. (Bloomberg)
â€˘ Australia's consumer prices rose faster than economists expected in the third quarter. (Bloomberg)
â€˘ Japan's trade surplus with the rest of the world jumped in September as the weak value of the yen helped exports of cars and electronics. (BBC)
â€˘ Key US Reports (WSJ):
7:00a.m.MBA Refinancing Index. Previous: -5.3%.
10:00a.m. Sept Existing Home Sales. Previous: -0.5%.
10:00a.m. Sept Chicago Fed Natl Activity Index. Previous: -0.18.
2:15p.m. Two-day FOMC mtg ends; interest rate decision expected.
â€śThere are a terrible lot of lies going around the world, and the worst of it is half of them are true.â€ť
FX Trading â€“ The Deficit Fallacy
On these pages we have argued over and over again that the deficit is not a reliable indicator to trade the dollarâ€”no matter how much financial pundits talk about it, the relationship is simply not there. We noticed this from Hoisington Investment Management Company (institutional bond managers) in their third quarter economic review and found it, well, validating.
THE TRADE DEFICIT
One of the most persistent worries concerning the bond market is the record trade deficit. As the logic goes, the deficit is so unmanageable that at any point foreign investors (who have taken U.S. paper in exchange for our "excessive" buying of their goods) may dump their dollars, forcing the dollar downward and the U.S. inflation rate upward. Our research indicates that these concerns are entirely misplaced.
First, attempting to find a correlation between the U.S. dollar and the trade deficit fails. Since 1974 the trade weighted dollar and the trade deficit register a correlation coefficient of 0. The "t" stat is a statistically insignificant .001 and carries the wrong sign. The obvious lack of correlation is confirmed by a graph of the two variables (Chart 3). For example, from 1995 to 2002, the trade deficit deteriorated by 442% while
the dollar gained 8%. In other words, there has never been a correlation between the U.S. dollar and the trade deficit. Assuming dollar weakness just based on trade is an unproven, and highly suspect conclusion.
Another fertile fallacy exposedâ€”thank you Hoisington!
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