I have been watching for a break of the lock-step FXE xs. SPX that was reflective of the carry-trade’s influence in the market the past year. Perhaps, this is it.

The Blue hatches in the chart represent the FXE(US$/Euro ETF) while the Red is that of the SP500. Looks interesting.

I have been watching for a break of the lock-step FXE xs. SPX that was reflective of the carry-trade’s influence in the market the past year. Perhaps, this is it.

The Blue hatches in the chart represent the FXE(US$/Euro ETF) while the Red is that of the SP500. Looks interesting.

The US$ has received the 3rd Degree by the media and their associated pundits of late. It seems that we as a society can never be happy unless we have something to worry about. The latest pending calamity is always in the headlines and great for advertising dollars but does little to educate a wider audience except to have them focus on the very short term and by this causes government officials to do the same in response(they do want to get re-elected so they better be responsive and “Do Something!”)

My view of the US$ which is plain to see below in the Trade Weighted Exchange Index and in the Brazil/ US and US/Euro Exchange Rate Indices is that the world is getting stronger as the US exports its greatest asset, i.e. capitalism, free markets and Democracy. In fact you cannot separate these three concepts from each other. They do not exist independently but are unique to freely operating and self-organizing societies and is the reason why the US remains greatly admired by aspiring societies and vilified by demagogues who seek personal power to the detriment of others. In free markets economic and political power is diversified throughout society to the greatest extent possible and leads to rapid innovation as well as reward.

As Socialist, Communist and Totalitarian governments evolve towards self-organized and free markets which they discover are the most productive in meeting their citizens’ needs, we should witness the US$ as having less importance in the world as the only safe haven available during times of geopolitical and economic despair. This is what I see in the Chart of “The Trade Weighted Exchange Index”. However, even during the recent crisis the US$ became a haven for many and this persists with T-Bills yielding less than 0.1% and 10yr Treasuries at ~3.5% and well below what historically has been the fair market rate of return currently 4.76%(Market Capitalization Rate). Fear persists.

The long term weakness in the US$ is in my view much more due to the improving relative liquidity, safety and rates of return in emerging Democracies. I include Europe as an emerging Democracy which began a dramatic change under Margaret Thatcher in the UK, was repeated in Ireland and now seems to be afoot under Merkel in Germany. This is a process that the US gradually exported with 50yrs of Cold War against the former USSR, protection of West Germany in a Democratic fold which was able to absorb with great magnanimity when the Berlin Wall fell. The courageous act by West Germany to absorb East Germany on October 3, 1990 with 1-1 currency swap exposed West Germany to an enormous but temporary inflation impact. Germany still supports the inhabitants of the former East Germany with subsidies, but has the economic vibrancy to do so.

One can see Democracy’s global expansion in both the Brazil/US and US/Euro Exchange Rate histories. (Note that the relationship to the US$ is inverse in Brazil/US chart vs. the US/Euro chart due to conventional use) Over the years as Brazil and Europe have become more capitalistic, more democratic and developed more towards freely organized markets the US$ has been in a gradual decline. The need to use the US$ as the sole reserve currency diminished over time as other financial markets and subsequently these currencies elsewhere have gained greater global confidence. THIS IS GOOD!!

But, in this most recent financial crisis in which almost all markets fully participated with their own home-generated excess lending behavior, the safe haven of last resort was and remains the US$. In this environment Bernanke had to supply not just liquidity to the US financial markets, but to the world which sought the safety of 233yrs of the US meeting its financial obligations. Bernanke expanded the Fed’s balance sheet to do this well beyond what many expected and this has caused in my view the current agita, panic, anxiety and general fear that we have lent too much, too quickly and that we will never be able to pay this off with our own economic activity. AND, this is topped-off with the argument that the US$ will become worthless with hyperinflation and etc, etc, etc.

I think not!

Bernanke in my view seems to understand all the risks and is in the process of reversing the liquidity as it becomes unnecessary. M2 growth, the accepted measure of money supply has been pulled back in recent months to the historical trend. It is not in Bernanke’s interest to tell the financial markets exactly when he will act as it reduces the Fed’s flexibility. But, he has made it clear that liquidity reversal will happen and that he is conscious of too much liquidity causing dangerous inflation.

US$ weakness over time is something we desire as a sign of spreading democracy. The success of this process is measured in decades not seconds. The media with 15sec sound-bites is taken out of context of a long term process of which we should be proud and quick to disparage. A proper understanding of history in which social, economic and political histories are viewed on a time line of decades and centuries is very helpful in our current situation.

Meanwhile, the current economic trend continues to improve.

If you remember “Davidson” has submitted a few posts on the dollar. Read them here and here. For those who wish not to read them, he essentially was saying that the dollar had most likely bottomed and was due for a rebound.

Then this from Barron’s:

At least Chavez didn’t have to worry about ponying up the bucks to pay for his Big Apple junket. His government was issuing some $3 billion in dollar bonds, split even between a 10-year maturity expected to carry a 7.75% coupon and a 15-year maturity with an expected 8.25% coupon. So, he’ll have plenty of greenbacks for his hotel bill, including whatever he got from the minibar.

The bond issue was designed to provide dollars to meet the demand for greenbacks among Venezuelans who, for some reason, would rather have dollar assets than their own bolivars. And the deal was working. Dow Jones Newswires reports from Caracas that the bolivar is up 25% from its August low, at 5.2 to the dollar in the “parallel” market, versus 7 to the buck a month or so ago, when greenbacks were scarce.

Venezuela thus joins the parade of foreign borrowers issuing bonds denominated in dollars. That means they’re expecting to pay back those debts in devalued dollars.

As noted in this space previously, borrowing dollars to put to work elsewhere at higher yields is an example of global carry trade. And that effectively is a short sale of dollars, a bet on their decline.

The dollar-carry trade has been gathering steam since it was written about here months ago (“Money for Nothing and Bucks for Free,” June 5,.) Earlier this month, Germany confirmed it would borrow in dollars to produce “savings for the federal budget,” which would result from the currency gain generated by the dollar’s decline.

Germany was followed by a flood of other offshore borrowers, from Abu Dhabi’s national energy company to Sweden’s Export Credit Corp to Hong Kong’s Hutchinson Whampoa, all eager to borrow and repay in ever-depreciating dollars. Now, comes Hugo Chavez and Venezuela jumping on the bandwagon, borrowing and thus shorting the greenback.

“That to me is a sign the short-U.S. dollar trade is ripe for a reversal, when basically the biggest idiot in the house is short,” writes Nic Lenoir of ICAP,

This may just be the clearest sign of a bottom there could ever be……

If you remember “Davidson” has submitted a few posts on the dollar. Read them here and here. For those who wish not to read them, he essentially was saying that the dollar had most likely bottomed and was due for a rebound.

Then this from Barron’s:

At least Chavez didn’t have to worry about ponying up the bucks to pay for his Big Apple junket. His government was issuing some $3 billion in dollar bonds, split even between a 10-year maturity expected to carry a 7.75% coupon and a 15-year maturity with an expected 8.25% coupon. So, he’ll have plenty of greenbacks for his hotel bill, including whatever he got from the minibar.

The bond issue was designed to provide dollars to meet the demand for greenbacks among Venezuelans who, for some reason, would rather have dollar assets than their own bolivars. And the deal was working. Dow Jones Newswires reports from Caracas that the bolivar is up 25% from its August low, at 5.2 to the dollar in the “parallel” market, versus 7 to the buck a month or so ago, when greenbacks were scarce.

Venezuela thus joins the parade of foreign borrowers issuing bonds denominated in dollars. That means they’re expecting to pay back those debts in devalued dollars.

As noted in this space previously, borrowing dollars to put to work elsewhere at higher yields is an example of global carry trade. And that effectively is a short sale of dollars, a bet on their decline.

The dollar-carry trade has been gathering steam since it was written about here months ago (“Money for Nothing and Bucks for Free,” June 5,.) Earlier this month, Germany confirmed it would borrow in dollars to produce “savings for the federal budget,” which would result from the currency gain generated by the dollar’s decline.

Germany was followed by a flood of other offshore borrowers, from Abu Dhabi’s national energy company to Sweden’s Export Credit Corp to Hong Kong’s Hutchinson Whampoa, all eager to borrow and repay in ever-depreciating dollars. Now, comes Hugo Chavez and Venezuela jumping on the bandwagon, borrowing and thus shorting the greenback.

“That to me is a sign the short-U.S. dollar trade is ripe for a reversal, when basically the biggest idiot in the house is short,” writes Nic Lenoir of ICAP,

This may just be the clearest sign of a bottom there could ever be……

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.

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.