Thursday, July 12, 2007

The dollar redux

If those legendary 80's musical mopers The Smiths were still actively recording, they would probably reconsider remaking one of their hit songs as "Dip-buyers of the World Unite." No doubt such a tune would be the theme song of Generation-Y financial market particpants, as yet again a risk event has (thus far) morphed into a buying opportunity. Whether that remains the case in the fullness of time remains to be seen, but for now we can evidently chalk up another victory to the dip-buyers of the world, perhaps masterminded by the nefarious Mrs. Watanabe.

Anatole Kaletsky had an interesting column in The Times this morning discussing the weak dollar and what it actually means. His brief discussion of the reasons for dollar weakness were woefully incomplete- not a single mention of Voldemort and friends!- but the contemplation of the weak dollar's implication is worth considering.

While modern hedging techniques can help delay and partially reduce the impact of exchange-rate pass through, over long periods of time the piper must eventually get paid, as Airbus is learning to its chagrin. That the US trade deficit has stabilized and even improved in the face of firm energy prices is, Macro Man believes, a testament to the impact of dollar weakness against European currencies in particular. We'll find out at 8.30 am New York time today whether this development continued in May.

Macro Man has mused before that the market is ignoring the cyclical dynamic in G4 currencies, potentially at its peril. The OECD recently updated its leading indicator series, and what do you know? Economic momentum is now stronger in the US (subprime and all!) than in Europe for the first time in a year and a half. If this trend extends over the next several months- and Macro Man sees no reason why it won't, given that Europe is just now feeling the bite of non-accomodative interest rates- this should, in the fullness of time, be reflected in currency prices.

News that CBs have perhaps filled their boots full of EUR for the time being is tempting Macro Man to sell some EUR/USD or GBP/USD here. However, he has toyed with the idea that the 'new range' for EUR/USD may have shifted to 1.35/1.39; therefore, it probably makes sense to wait and sell as close to 1.39 as possible.

Morever, it's not as if CB reserves are staying static. BOK was evidently in the market after hiking rates last night, and RBI ramped USD/INR higher early in the London session. Actions such as RBI's leave Macro Man shaking his head when he reads analyses suggesting that the US is somehow addicted to CB financing of the current account deficit. Deficits will always be financed at the appropriate price. As India has found, delaying that appropriate price from being reached can have unintended and unpleasant consequences (e.g., inflation.) At market-clearing exchange and interest rates, the private sector will be happy to finance the US current account- which, incidentally, would almost certainly be smaller (and thus easier to finance) at market-clearing prices that it is today.

After all, it's important to remember that there's more to the US economy than a fast-food nation of SUV drivers!


Quarrel said...

Ah. Had to put "Louder Than Bombs" on (well, on iTunes) straight after reading this.

Morrissey and Marr - what genius. (Apologies to the Yanks, who presumably know nothing of the Smiths?)

Meanwhile as I watch thinking maybe that construction might start finally start passing on some of the job losses US jobless figures come in lower .. Trade gap is worse however, so naturally US futures show a strong open for equities.

Tomorrow's retail sales are looking weak however, despite Walmart's valiant fight.

Anyway, despite liking your broad assessment of the cyclical move, I worry that Roubini et al having their money on a weakened US consumer are still making the correct call. Housing price falls will continue to bite HARD.


tmcgee said...

i still doubt el consumer has been just all that seriously undermined by the housing bust. mr. ritholtz has some interesting guesstimations that credit cards are (again?, as ever?) replacing housing ATMs. but i still think this has to do with a serious misunderstanding of the US hosuehold/consumer: that all spending is either debt- or housing-financed in some gluttonous, sinful manner. the worst money over the past seven years, mostly, has been betting against the US consumer. and i don't think bear stearns nor S&P is going to change that.

as for currencies, given some of the conclusions here that your friendly global central banks are dominating FX markets -- how much would it really matter if the US economy rebounds better than expected? does that really affect the pace of their reserve accumulation or reallocation? part of me really doubts it. there haven't really been that many reasons to sell the dollar over the past week, despite whatever the press says, and it seems to happen just the same every london AM. so, do fundamentals really matter at all beyond the pace of US deficits, China/ME/Russia reserve building and the eventual reallocation? maybe i'm becoming too much of a pessimist...v

Macro Man said...

Q, the Smiths did indeed make it across the Atlantic and were highly popular amongst a certain set in the 80's.

I'd concur with Mr. McGee, however, and suggest that while consumption has indeed slowed recently, extrapolating that forward in the absence of corporate distress is risky business.

House prices only really bite if you don't have a job; after all, there is nothing to force you to realize a loss by selling your house as long as you can pay the mortgage. Moreover, the impact of MEW has, in my view, been overstated, particularly over the last couple of years.

Tim, I think a change in US (or indeed) fortunes can have an impact, as 2005 demonstrated. While I don't necessarily think that we'll see another 15% move lower in EUR/USD, I do think it could be good for 3-4 figures if timed correctly.

And in today's EUR/USD market, that almost qualifies as a 3 standard deviation move!

Quarrel said...

MM- good to know re the Smiths. My own long stints in the US are far too recent.

Tim, I tend to be convinced by Mr Setser (and MM) that the CBs are swamping the fx markets. But with 70% of US GDP accounted for by the consumer I think it is hard to discount their effect one way or the other.

Certainly I think your point should be well taken that the US consumer has proved resilient, and betting against them hasn't been fun.

If the future growth of CB reserves continues, and they're broadly denominated in US and Euro's as they seem currently destined to be, rather than pouring in to local (EM) markets, then the liquidity fun will be far from over, and that could well keep the US consumer in credit joy for a good while yet.

If defaults stay low too, then the so called CDO put could even save us from the credit meltdown..

Anyway, I'm all in favour of US strength, but will keep my eye on the housing market and its fallout just the same..


Anonymous said...

The Time's article is amusing but looking currencies as nation's symbols of pride and dominance is completely outdated nowadays. In the world dominated by inflation targeting and free flow of funds "macro models" are the true rulers.

In my opinion conditions for further dollar weakness has increased since last month, falling core cpi and consequently higher real interest rates is in contradiction with the oecd leading indicator wich reflects stock market optimism and yield curve steppening...

Anonymous said...

This guy runs some funds with a partner and spouts in this paper with no disclosure whatsoever. ZIRP for everyone anyone?