And so it begins...

Well, you can't say that Macro Man didn't warn you. More than two months ago, he suggested that Fed easing of 0.50% or more could generate a 'dollar down bubble.' After the initial Fed easing, he warned that the buck was toast. And so it's come to pass, with the USD falling steadily since he first voiced his concerns. Until recently, however, the dollar's decline has been relatively orderly, and not characteristic of the "throw caution to the wind" price action that one normally associates with bubbles. All that may have changed today, however, as the buck is falling hard against every currency under the sun, including erstwhile whipping-boy the yen. It looks like the real meat of the dollar down bubble has begun.
The immediate cause of the dollar's collapse today was frankly something of a joke. Cheng Siwei, vice-Chairman of the National People's Congress, said that China will "favour strong currencies [for its reserve basket] over weak ones, and will adjust accordingly." The dollar has collapsed ever since the words left Mr. Cheng's lips.

Now, there are three basic facts that one should know about Mr. Cheng in interpreting his comments:

1) He has no position at SAFE, and no position of influence over SAFE. In other words, his comments carry no particular policy insight.

2) This is the same chap who tried to talk down Chinese equities in Q1. Needless to say, those that acted on his advice have regretted it.

3) Mr. Cheng is actually the leader of an opposition party. Given what we know about the Chinese Communist Party and their desire to retain power, you can reach your own conclusions about the type of chap that they would allow to run a legal opposition party.

Simply put, Mr. Cheng is talking out of his 括約肌 when he discusses financial markets. But the reaction has been very telling indeed. EUR/USD has traded a percent higher from yesterday's NY close, and USD/JPY is at its lowest level since early September. CAD, AUD, and just about everything else under the sun (including the RMB!!!) have also surged against the dollar. And as noted above (and forecast on October 1) , the USD has traded to a new all-time low against the EUR as proxied by the old Deutsche Mark.

So does it matter? Will anyone but currency speculators and exporters give a damn? In Macro Man's worldview, when dollar weakness morphs from orderly and economically justified to bubble territory, macroeconomic consequences begin to arise. For example, S&P futures have already erased all of yesterday's stunning gains. Perhaps more importantly, however, commodity prices have surged, with oil flirting with $100 and gold with its all time highs of $850.

This is where the weak dollar begins to have negative consequences. One could argue that the hawkish comments from Charles Plosser may have been partially motivated by dollar weakness. More importantly, breakevens are starting to widen sharply; at 2.45%, the 10 year breakeven is near its wides of the year. If the Fed receives market signals that inflation is becoming more of a worry, then they will set monetary conditions tighter than would otherwise would be the case. The upshot for risk assets is a negative one, one one might even argue that the dollar down bubble could sow the seeds of its own destruction if it provokes a policy response.

It therefore would appear prudent to do more than take a victory lap (that is not Macro Man's intent with this post, though it may come across that way) on the dollar bear view; Macro Man is now prepared to take some profits. He therefore exits the Dec gold position at just over $845. If Macro Man is right and we're now in dollar bubble territory, he can run a smaller notional and still generate substantial profits.

And if The Economist decides to put the buck on the cover and call an interim top in the euro....it's easier to book more profits having already done so near the highs.

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19 comments

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CDN Trader
admin
November 7, 2007 at 11:40 AM ×

Macro man, I tend to agree with you. When markets throw caution to the wind, you know the turning point is not far away. This may finally lead to the US$ retracement that everyone has been predicting the past few weeks. I remain a long-term dollar bear, but I am sceptical we will see 1.50 within the month. Likewise with gold.

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November 7, 2007 at 12:28 PM ×

My favorite part: "you can reach your own conclusions about the type of chap that they would allow to run a legal opposition party." LOL!

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Anonymous
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November 7, 2007 at 1:26 PM ×

Seeking some quick wisdom on this, I'm thankful for you informative post this morning. In particular, Dennis Gartman seems to be flailing around saying quite the opposite about the relevance of Mr. Cheng's comments.

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Andrei
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November 7, 2007 at 3:11 PM ×

Yes, I agree with your comments, but from a technical analysis standpiont, if you look at the $USD index, it has only reached the bottom of its channel line, and has hit an oversold point with RSI. I would in fact buy, short term, as long as it doesnt break that support. Happy trading. :-)

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"Cassandra"
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November 7, 2007 at 5:44 PM ×

Is that Mr "T" kicking the crap outta GW?

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Macro Man
admin
November 7, 2007 at 6:12 PM ×

Andrei, the buck is clearly oversold and the hysteria levels are high. That having been said, trending markets often post overbought/oversold readings for extended periods; osciallators like RSI and stochastics are most useful, I've found, in sideways rather than trending markets.

C, it is indeed Mr. T in Clubber Lang guise. In a remarkable coincidence, I first saved off the picture in August as part of a "mark-to-model" (a pristine Rocky) versus mark-tomarket (this photo sans GW) gag that I sent round to a few buddies in the marke.

The basic message was alluded to here.

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Anonymous
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November 7, 2007 at 7:31 PM ×

MM, your no-recession comments in the face of mounting evidence day after day makes me think you would be a excellent replacement for Tony Snow

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Macro Man
admin
November 7, 2007 at 8:34 PM ×

Gee, in 295 posts so far this year, the word "recession" (as in "no recession") has been mentioned in 24 of them.

The day-after-day evidence suggesting imminent recession would be....7% y/y personal income growth? 4% annualized growth in Q2 and Q3? A continued improvement in the trade deficit? Inventory/sales ratios remaining at extremely healthy levels?

My job is to make money. When my P/L tells me I am wrong, I'll change my mind. When the facts change, I'll change my mind. It does me no good whatsoever to forecast a recession two years in advance; in my line of work, early is the same as wrong. As long as I can forecast a recession (or a recovery, or whatever) a day before the next guy, I will make money.

I am happy to leave the headline chasing and chest beating to those who are more interested in their media careers than making money.

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Anonymous
admin
November 7, 2007 at 9:08 PM ×

Well, you see what happens when they try to defend the dollar: the stock market tanks (led by financials) AND the dollar keeps falling. Better to stick with the old policies.

More rate cuts, please.

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OldVet
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November 7, 2007 at 9:09 PM ×

Hard to believe that caution has been thrown to the winds when more bad news for the dollar is yet to come, mainly in banking and housing sectors along with some auto firms. Asset accounting may be what has gotten hysterical, like the "deferred tax benefits" of GM, which vanish under the "likelier than not" rule, along with hypothetical profits which supported them. A few Stop Losses do seem to be in order as a matter of prudence, but why cut your profits short by selling?

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November 7, 2007 at 9:33 PM ×

"I am happy to leave the headline chasing and chest beating to those who are more interested in their media careers than making money."
You don't think they *pay* Ritholtz to go on CNBC?

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lcch
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November 7, 2007 at 9:52 PM ×

Macro man, i have been reading your blog for sometime now. Im no longer in financial markets, but your blog still captivates my full attention. Positive externality all the way! Ill buy a share or two in macroman industries.

your excellent work is very much appreciated.

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Macro Man
admin
November 7, 2007 at 10:02 PM ×

OldVet, when markets get hysterical and begin to pay any price, I find that that's usually a good time to at least think about ringing the register.

In the case of gold, it's near enough to its all time high, and having taken close to $100 out of it in less than a month, I am happy to move to the sidelines. Just in time too: all three Fed speakers today mentioned the dollar/commodities in either the prepared remarks or the Q&A...which is just the sort of thing I was concerned about in the post.

Bill, the media whore is as much a feature of modern finance as dodgy structured credit, Chinese FX intervention, and a bubble-blowing Fed. I don't watch CNBC so cannot comment on specific individuals, but one does tend to find the same names/faces in media outlets with rather more frequency than one might wish.

And while I suppose I, too, am a media whore for writing this blog, at least one can avoid me by not visiting, an option that 99.9999% of the world is happy to choose!

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Macro Man
admin
November 7, 2007 at 10:05 PM ×

lcch, very much obliged for your kind words, and I'll bear you in mind should I ever want to do a prviate placement ;)

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OldVet
admin
November 7, 2007 at 10:47 PM ×

mm, thanks. I did put in Stops today because I've got the worst record in the universe on market timing. Still, the dollar bubble won't be talked away soon by FedHeads, in light of forced disclosures by firms, yet to come. Cheers, and thanks for your blog.

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CV
admin
November 7, 2007 at 10:53 PM ×

Ok Macro Man ...

Claus v Macro Man ... 0-1 :)

I have to say that the a EUR/USD trading persistingly over 1.45 was not on my radar at all; mainly becaus this was the threshold I saw/see as where things begin to look bad indeed for the Eurozone and the ECB.

Now, this is also what surprises me most in this current environment. Not so much that the Dollar should be falling (e.g. in trouble) but more so the flipside since the Eurozone just simply cannot muddle 'along.' Of course, I still maintain that this bet on de-coupling/re-balancing is wholly unsustainable but that does little in the way of the fact that we have to realize that this is the way markets are moving at the moment.

Ironically, and this is of course a general part of the whole macroeconomic edifice at this point it seems as if Milton's old dictum of how inflation is a monetary phenomenon and all seems to be rather turned upside down at the moment when it comes to the traditional 'remedies' right? I mean, with all that liquidity floating about raising rates to curb inflation or demand/ activity (Australia anyone?) will only serve to suck in more capital and thus fuel that much watched and hailed M3 gauge. In many ways, there seems to be a pretty perverse interpretation of 'yield' at the moment solely based on movments in short term interest differentials with no regard to underlying fundamentals. Ok, there are considerable side issues to this; i.e. what kind of capital flows are we seeing, is the diversification real etc. But still, makes you wonder.

Meanwhile Macro Man, keep up the good work and dare I say it; is now the time to wheel in the profit on those long EUR/USD?

Claus

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Anonymous
admin
November 7, 2007 at 11:43 PM ×

MM,come on man, should Dana perino get sick you should be the first in line in teeling people statistics on how violence in iraq is down. how often you see a large economic imbalance in housing like this without a recession?nevermind with $100 oil

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Manas
admin
November 8, 2007 at 2:23 AM ×

Hi Macroman,
I've been one of your regular readers for years, once having gone to the extent of asking you for a quote. I was so impressed with your piece on Petrochina that I felt compelled to mention it in my column, without waiting for your permission. Hope you'll excuse me. Here's the link---it's the second item. http://www.livemint.com/2007/11/07234759/Private-sector-banks-shine-in.html

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Macro Man
admin
November 8, 2007 at 11:10 AM ×

Claus, in my mind taking profits on gold is equivalent to taking some EUR off the table. The facts is, however, that CBs continues to buy EUR/USD at these inflated levels, and I expect them to continue that activity through year end. Risks are clearly there, as I allude in today's post, but until they materialize that is all they will be.

Anonymous, I don't even know who Dana Perino is, but I assume it's not intended as a compliment. Last time I checked, gas stations sold gasoline rather than barrels of crude, and gas prices are quite a bit lower than they were in the spring. I've been fairly explicit that if/when that changes, I am prepared to change my mind.

As far as I am aware, I've never mentioned Iraq in this space and have no intention of doing so. I call things as I see them and alter my view as the facts change; I'm certainly not infallible, but if my way of thinking offends you, there's always the option of joining the other 99.9999% of planet Earth and looking elsewhere.

Manas, thanks for your kind words and I appreciate the heads up.

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