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.