Thursday, September 20, 2007


Toast. Not only is it a wonderful breakfast food- tasty with honey, jam, marmalade, butter, or even dry-but it is also a pretty accurate description of the current parlous state of the US dollar.

Macro Man has long been more favourably disposed to the buck than many. His disavowal of the "dollar must go down forever" thesis is one of the reasons that he (unfortunately) didn't delta hedge his powerball strip. However, even his patience has its limits. A few weeks ago, he noted that any aggressive gesture from the Fed to bail out turd-holders and reflate asset markets would force him to turn structurally bearish.

That has now come to pass, and in what Dennis Gartman might refer to as a "Watershed" moment, Macro Man has lost faith in George Washington. Simply put, if the Fed doesn't give a crap about protecting the purchasing power of the dollar, why should anyone hold it?

We've reached a rather interesting juncture in EUR/USD, at least if you are a fan of arcana like Macro Man. Not only has EUR/USD breached 1.40 for the first time, but it is now trading "above" its implied USD/DEM equivalent (on the basis of the EUR/DEM conversion rate of 1.95583) for the first time. This might only interest a finance geek like Macro Man, but he still thinks it's telling.
Impetus for the dollar's latest downturn has come from panic-monger extraordinaire Ambrose Pritchard-Evans, who highlights in this morning's Torygraph the growing risk that Middle Eastern countries abandon their dollar peg. While the headline might be straight out of the Sun or New York Post (the author must be short dollars p.a.), the theme is a very real one.

Inflation in the Middle East is rising due to three factors: "Dutch disease" oil revenues, artificially low rates resulting from the dollar peg, and the weakness of the buck in foreign exchange markets, particularly against those regions from which the Middle East imports most of its goods. The trend in UAE inflation, while perhaps more dramatic than in other countries, is neverthless emblematic of the problem at hand.

They had 9% inflation last year, which will almost certainly print double digits this year. Why, then, are rates at 4.7% and the dirham allowed to slide down the toilet? The obvious solution is to break the peg....which, in the case of Saudi Arabia, could disrupt a source of large price-insensitive capital flows into the US.

The trend seems clear, therefore-at least until The Economist puts the dollar on its cover. Rallies should be used as an oppurtunity to add to dollar shorts. In the meantime, however, gold may offer the best risk/reward opportunity. $730 is a massive level in bullion; a break should target $850 in fairly short order. Macro Man will therefore stop into longs at $742 in the Dec futures contract, adding to the exposure he has from options.

Finally, Swervin' Mervyn has testified before the Treasury Select Committee today. In a shocking, SHOCKING development, King has defended the bank's actions and blames the apparent inconsistencies on other people/organizations. Sorry, Merv: you've blown it.

And for what reason? NRK continues to head lower, and rumours are swirling that HBOS and Alliance and Leicester are preapring to step up to the BOE's liquidity milk-teat. Please, everyone....form an orderly queue.

Finally, today's equity action is likely to be driven by Goldman and Bear Stearns earnings. So far Lehman has beaten estimates whil Morgan Stanley missed. But the real action should be today: Bear was at the epicenter of the subprime earthquake, while GS has both a superior reputation and more proprietary exposure. Still- things are unlikely to be that bad. A Goldman friend of Macro Man's mentioned on the train this morning that he hopes GS misses that his bonus allocation (paid in GS stock) will be at a lower price level...


Manc Trader said...

Agree with the sentiments MM

This final cut from the fed reminds me of the fat guy from Monty Python's
Meaning of life.
Will this final "mint" at the end of a 25 year orgy of rate cutting to solve all problems lead to this:

Frog said...

It's time for a coordinated intervention by ECB, FED, RBA, BOC, BOJ to prop up the USD. I don't know what will happen if the selloff of the USD deepens. But I know it will be much worse than NRK going under.

Macro Man said...

Frog, I think the chances of the US intervening to "save the dollar" anywhere near curent levels are somwhere between nowt, zero, and no effing way.

A slowing economy, still-large trade deficit, uncompetitive auto industry, and upcoming political calendar would make it political suicide to intervene to support the dollar.

It would be tantamount to the ethnic cleansing of the Republican Party as a political force for the foreseeable future.

frog said...

GWB might not understand the consequence of a USD collapse but I am sure Paulson and Bernanke might try something to at least slow down the decay. DXY at 78.83 looks scary.

Macro Man said...

It's veeerrrrryyyyyy difficult to see Paulson caring until and and un
less his ability to sell Treasury bonds is compromised. We're nowhere near there yet.

Otherwise, supporting the dollar is just offering a subisdy to Toyota, BMW, Airbus, et al.

Anonymous said...

MM, I see the dollar falling from another angle. Knowing that Paulson and Co wants the Chinese to delink their currency, and the Chinese not willing to move, why not force them to move via inflation. Lower dollar, lower yuan, and higher inflation.
Who will blink first? Will be interesting to see inflation numbers from China in the coming months.


macro fan said...

Sniff...sniff...what's that I smell? It's definitely toast...yes...but is it the dollar or the chary remains of a consensus of opinion that got burned trying to jimmy it out before it was done? My mother taught me to be real careful around toasters.