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 earnings...so that his bonus allocation (paid in GS stock) will be at a lower price level...