Whistling DXY

After a weekend of sober reflection (well, sober until the first bottle of vin rouge was cracked open), Macro Man's interpretation of Friday's employment report is largely unchanged. While the figure does not represent or guarantee a recession, it does seem clear after the revisions that the trend of payroll growth has decelerated. Henceforth, Macro Man may not even look at the "timely" payroll data, and instead concentrate his energies on analyzing the revised, presumably more accurate, prior data.

The extent of the rally in fixed income certainly tells you what the market wants to believe; namely, that the US economy is barrelling forward headlong towards recession. While rates at the short end obviously reflect some of the distress in credit markets, the break of yield support at the long end suggests that it's not all down to LIBOR issues.

A bull steepening of the yield curve, which the US has seen over the last couple of months, is not particularly positive for the buck. Specifically, at the short end, US govvy yields no longer offer a premium over those of the Eurozone. As the chart below illustrates, the US-German 2 year spread is back at par for the first time since Q4 2004. And that was a period in which the dollar was under very significant pressure indeed.
While USD/JPY has justifiably received most of the headines, the buck is showing weakness against a broader range of currencies. In contrast to price action observed during August, USD/CNY fell "sharply" overnight, declining by 0.25%. And EUR/USD is back up near all time highs. Macro Man belatedly bought some on Friday, though gains have thus far been limited (perhaps due to the defense of a 1.38 barrier, rumoured to roll off today.) Nevertheless, the buck (as proxied by the DXY, which itself is little more than a proxy for EUR/USD) is breaking some absolutely critical levels.
In the history of the DXY, 80 has been something of a "no fly zone". While the index closed below that level in August 1992, the ERM crisis the following September helped propel the greenback higher. Otherwise, the index has rejected 80 pretty forcefully on each of its prior visits to the level.
As such, last week's close just below 80 raises a red flag that perhaps Macro Man's view of dollar weakness forming the next financial bubble could occur sooner rather than later. Macro Man is therefore switching to high alert.


Previous
Next Post »

10 comments

Click here for comments
Anonymous
admin
September 10, 2007 at 11:21 AM ×

MM,
Could you kindly elaborate on dollar weakness would manifest itself as a bubble?

Is it through sharply higher commodities prices that you have in mind?

Ta.

Reply
avatar
Macro Man
admin
September 10, 2007 at 11:30 AM ×

No, via an extremely cheap foreign exchange value. Think EUR/USD 1.50-1.60, USD/JPY 90-95, USD/CAD below par, AUD/USD close to par, etc.

Reply
avatar
T
admin
September 10, 2007 at 11:55 AM ×

Isn't it more appropiate so see it as a dollar stength bubble unwinding? Strikes me that a large normalisation is going on more than anything.

Reply
avatar
Macro Man
admin
September 10, 2007 at 1:00 PM ×

I'd argue that the only bubble of dollar strength is that perpetrated by the FX reserve managers- i.e FX reserve accumulation is itself a bubble. However, it's hard to see that popping any time soon.

Against non-pegged currencies, most of the private sector has run short dollar positions for a number of years now (Japanese retail being the obvious exception.)

The apocalyptic worldview (still a risk case, but one I seem to assign a higher probability to every day) is that those get much, much bigger.

Reply
avatar
tmcgee
admin
September 10, 2007 at 2:44 PM ×

i just wonder about the meaning of DXY, a trade-weighted index whose weights are not really changed (and thus is just a dirty EUR/USD proxy as you say). can that much meaning be derived from it still, or event technical significance?

Reply
avatar
Banker
admin
September 10, 2007 at 2:50 PM ×

Macro Man

If you were allowed ...one trade and one trade only... What would it be ?

Reply
avatar
tmcgee
admin
September 10, 2007 at 2:54 PM ×

btw, nice title. i almost want to go sing allman brothers or lynyrd skynrd at karaoke (which indeed is available at the neighborhood joint)...

Reply
avatar
Macro Man
admin
September 10, 2007 at 3:19 PM ×

Banker, I have a rather sexy trade in the pipeline which I will elaborate on when the timing is ripe, and I suppose that would be the trade!

Reply
avatar
Anonymous
admin
September 10, 2007 at 5:23 PM ×

macroman --

given all the teasers about your sexy trade, I had better be a real Gisele Budchen, so to speak

bsetser

Reply
avatar
Macro Man
admin
September 10, 2007 at 5:42 PM ×

Hmm, I shouldn't make too many promises. One man's Gisele is another man's, er, Rosanne Barr so to speak.

But I think it's pretty cool.

Reply
avatar