Free Post: “Davidson” on the Dollar Trade
- Posted by ToddSullivan
- on September 20th, 2009
“Davidson” is back with some thoughts on the USD/Euro..Don’t trade currencies myself nor do I know to much about trading them. I do know this though: At the end of March, when the world was curling up into the fetal position and the markets hit lows, Davidson said this to me “I am all in” (the market)……. for that, what he sends to me bears close reading and consideration..
The Conundrum of a Falling Dollar
In the past few weeks there has been an acceleration of the slide in the US$ which after multiple consultations with various sources leads me to believe that it is likely over done and at risk of reversal. The Euro/US$ relationship is presented in the chart below which you can expand by clicking on the “Forward” button above and then clicking and dragging the corner tabs on the chart.
There are multiple reasons for investors to sell the US$ vs. other currencies. Firstly and most importantly is that market psychology has improved and risk capital has left the safety haven of the US$ and partially returned to EmgMkts, Nat Resources and other asset classes. Secondly, global trade has improved considerably along with the conversion of US$ into commodities and business activities. Lastly, it appears quite likely that Hedge Funds have actively placed momentum trades by shorting the US$ to participate in the corresponding price movements. This is called the “Carry Trade”. Characteristic of the Carry Trade phenomena is the observation that Treasury rates fall in the face of enormous issuance by the US Government to fund financial market support while at the same timemany fear soaring commodity prices as a sign of inflation. This is not confusing!
Falling US Treasury rates and soaring commodity prices have the same source, i.e. the Carry Trade! The Carry Trade with T-Bill rates at ~0.1% works to buy 10yr Treasuries at 3.4% to capture the spread just as well to buy uptrending gold, copper and oil.
It will not be possible in my opinion to determine with any precision when this will reverse, but there is considerable risk even today that should Bernanke raise the Fed Fund rate by even 0.25% this trade could collapse. I do not think from what I read in the media that Bernanke is likely to raise rates in the near term. But, I do think that our last excess of Euro/US$ of 160.5 in the week of April 25, 2008 may cause market participants to reverse carry trade positions. Not knowing what may or may not transpire the next few months, I suggest that the allocation to Sovereign Debt managers allocation be moved to US Domestic Debt managers should the Euro/US$ rise over 150. See the horizontal BLUE line on the chart.
The current yield of Sovereign Debt managers is falling with each up-tic and is currently well below the Market Capitalization Rate(MCR) of 4.85% while that of alternative US Domestic Debt managers is currently quoted at ~6.6% which is well above the MCR.
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